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Modelling the joint behaviour of electricity prices in interconnected markets

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  • Troels Sønderby Christensen
  • Fred Espen Benth

Abstract

The liberalization of energy markets worldwide during recent decades has introduced severe implications for the price formation in these markets. Especially within the European day-ahead electricity markets, increased physical connections between different market areas and a joint effort on optimizing the aggregate social welfare have led to highly connected markets. Consequently, observing the exact same hourly day-ahead prices for two or more interconnected electricity markets in Europe happens frequently. This affects the modelling of such prices and in turn the valuation of derivatives written on prices from these market areas. In this paper, we propose a joint model for day-ahead electricity prices in interconnected markets composed of a combination of transformed Ornstein–Uhlenbeck processes. We discuss the properties of the model and propose an estimation procedure based on filtering techniques. Furthermore, the properties of the model reveal that analytical prices are attainable for, e.g., forwards and spread options.

Suggested Citation

  • Troels Sønderby Christensen & Fred Espen Benth, 2020. "Modelling the joint behaviour of electricity prices in interconnected markets," Quantitative Finance, Taylor & Francis Journals, vol. 20(9), pages 1441-1456, September.
    • Handle: RePEc:taf:quantf:v:20:y:2020:i:9:p:1441-1456
    DOI: 10.1080/14697688.2020.1733059
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    Cited by:

    1. Deschatre, Thomas & Féron, Olivier & Gruet, Pierre, 2021. "A survey of electricity spot and futures price models for risk management applications," Energy Economics, Elsevier, vol. 102(C).
    2. Edoardo Berton & Lorenzo Mercuri, 2021. "An Efficient Unified Approach for Spread Option Pricing in a Copula Market Model," Papers 2112.11968, arXiv.org, revised Feb 2023.
    3. Erwan Pierre & Lorenz Schneider, 2024. "Intermittently coupled electricity markets," Post-Print hal-04411166, HAL.
    4. Godin, Frédéric & Ibrahim, Zinatu, 2021. "An analysis of electricity congestion price patterns in North America," Energy Economics, Elsevier, vol. 102(C).

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