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A new index for electricity spot markets

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  • Falbo, Paolo
  • Fattore, Marco
  • Stefani, Silvana

Abstract

Different indexes are used in electricity markets worldwide to represent the daily behavior of spot prices. However, the peculiarities of these markets require a careful choice of the index, based on mathematical formulation and its statistical properties. Choosing a bad index may influence the financial policies of market players, since derivative pricing and hedging performance can be deeply affected. In this paper with an initial theoretical analysis, we intend to show that the most widely used indexes (simple arithmetic average and weighted average with current volumes) are poor representatives of the spot market. We will then perform an analysis of the hedging strategy on a derivative instrument (an Asian option) written on a reference index. The resulting simulations, applied to OMEL (Spain) and EEX (Germany), are sufficiently clear cut to suggest that the decision to adopt an index to represent properly a market must be taken very carefully. Finally we will propose a new index (FAST index) and, after comparing it with the previous indexes, will show that both theoretically and practically this index can be taken as a good electricity market synthetic indicator.

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Bibliographic Info

Article provided by Elsevier in its journal Energy Policy.

Volume (Year): 38 (2010)
Issue (Month): 6 (June)
Pages: 2739-2750

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Handle: RePEc:eee:enepol:v:38:y:2010:i:6:p:2739-2750

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Web page: http://www.elsevier.com/locate/enpol

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Keywords: Electricity markets Market index Derivative pricing;

References

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  1. Juan Toro & Natalia Fabra, 2002. "Price Wars and Collusion in the Spanish Electricity Market," Economics Series Working Papers 136, University of Oxford, Department of Economics.
  2. Catherine D. Wolfram, 1999. "Measuring Duopoly Power in the British Electricity Spot Market," American Economic Review, American Economic Association, vol. 89(4), pages 805-826, September.
  3. Marco Fattore, 2007. "Axiomatic properties of geo-logarithmic price indexes," Working Papers 20071103, Università degli Studi di Milano-Bicocca, Dipartimento di Statistica.
  4. Forni, Mario & Hallin, Marc & Lippi, Marco & Reichlin, Lucrezia, 1999. "The Generalized Dynamic Factor Model: Identification and Estimation," CEPR Discussion Papers 2338, C.E.P.R. Discussion Papers.
  5. Mello, Antonio S & Parsons, John E, 2000. "Hedging and Liquidity," Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 127-53.
  6. Balk,Bert M., 2008. "Price and Quantity Index Numbers," Cambridge Books, Cambridge University Press, number 9780521889070, April.
  7. Deng, S.J. & Oren, S.S., 2006. "Electricity derivatives and risk management," Energy, Elsevier, vol. 31(6), pages 940-953.
  8. Geman, Hélyette & Roncoroni, Andrea, 2003. "A Class of Marked Point Processes for Modelling Electricity Prices," ESSEC Working Papers DR 03004, ESSEC Research Center, ESSEC Business School.
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