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Liquidity risks on power exchanges

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  • DE MAERE D’AERTRYCKE, Gauthier

    ()
    (Université catholique de Louvain, CORE and INMA, B-1348 Louvain-la-Neuve, Belgium)

  • SMEERS, Yves

    ()
    (Université catholique de Louvain, CORE and INMA, B-1348 Louvain-la-Neuve, Belgium)

Abstract

Financial derivatives are important hedging tool for asset’s manager. Electricity is by its very nature the most volatile commodity, which creates big incentive to share the risk among the market participants through financial contracts. But, even if volume of derivatives contracts traded on Power Exchanges has been growing since the beginning of the restructuring of the sector, electricity markets continue to be considerably less liquid than other commodities. This paper tries to quantify the effect of this insufficient liquidity on power exchange, by introducing a pricing equilibrium model for power derivatives where agents can not hedge up to their desired level. Mathematically, the problem is a two stage stochastic Generalized Nash Equilibrium and its solution is not unique. Computing a large panel of solutions, we show how the risk premium and player’s profit are affected by the illiquidity.

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Bibliographic Info

Paper provided by Université catholique de Louvain, Center for Operations Research and Econometrics (CORE) in its series CORE Discussion Papers with number 2010005.

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Date of creation: 01 Feb 2010
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Handle: RePEc:cor:louvco:2010005

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Related research

Keywords: illiquidity; electricity; power exchange; artitrage; generalized Nash Equilibrium; equilibrium based model; coherent risk valuation;

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