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A structural risk-neutral model of electricity prices

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Author Info

  • René Aid

    (EDF R&D - EDF, FiME - Laboratoire de Finance des Marchés d'Energies - Université Paris Dauphine - Paris IX)

  • Luciano Campi

    ()
    (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris Dauphine - Paris IX)

  • Adrien Nguyen Huu

    (EDF R&D - EDF, CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris Dauphine - Paris IX)

  • Nizar Touzi

    (CMAP - Centre de Mathématiques Appliquées - Ecole Polytechnique - Polytechnique - X - CNRS : UMR7641)

Registered author(s):

    Abstract

    The objective of this paper is to present a model for electricity spot prices and the corresponding forward contracts, which relies on the underlying market of fuels, thus avoiding the electricity non-storability restriction. The structural aspect of our model comes from the fact that the electricity spot prices depend on the dynamics of the electricity demand at the maturity $T$, and on the random available capacity of each production means. Our model explains, in a stylized fact, how the prices of different fuels together with the demand combine to produce electricity prices. This modeling methodology allows one to transfer to electricity prices the risk-neutral probabilities of the market of fuels and under the hypothesis of independence between demand and outages on one hand, and prices of fuels on the other hand, it provides a regression-type relation between electricity forward prices and forward prices of fuels. Moreover, the model produces, by nature, the well-known peaks observed on electricity market data. In our model, spikes occur when the producer has to switch from one technology to the lowest cost available one. Numerical tests performed on a very crude approximation of the French electricity market using only two fuels (gas and oil) provide an illustration of the potential interest of this model.

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    File URL: http://hal.archives-ouvertes.fr/docs/00/40/30/25/PDF/ElecSpotForward_final.pdf
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    Bibliographic Info

    Paper provided by HAL in its series Post-Print with number hal-00390690.

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    Date of creation: Nov 2009
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    Publication status: Published, International Journal of Theoretical and Applied Finance, 2009, 12, 7, 925-947
    Handle: RePEc:hal:journl:hal-00390690

    Note: View the original document on HAL open archive server: http://hal.archives-ouvertes.fr/hal-00390690/en/
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    Web page: http://hal.archives-ouvertes.fr/

    Related research

    Keywords: energy markets; electricity prices; fuel prices; risk-neutral probability; no-arbitrage pricing; forward contracts;

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    Cited by:
    1. Rene Carmona & Michael Coulon & Daniel Schwarz, 2012. "Electricity price modeling and asset valuation: a multi-fuel structural approach," Papers 1205.2299, arXiv.org.
    2. Füss, Roland & Mahringer, Steffen & Prokopczuk, Marcel, 2013. "Electricity Derivatives Pricing with Forward-Looking Information," Working Papers on Finance 1317, University of St. Gallen, School of Finance.
    3. René Aïd & Luciano Campi & Nicolas Langrené & Huyên Pham, 2012. "A probabilistic numerical method for optimal multiple switching problem and application to investments in electricity generation," Working Papers hal-00747229, HAL.
    4. Ren\'e A\"id & Luciano Campi & Nicolas Langren\'e & Huy\^en Pham, 2012. "A probabilistic numerical method for optimal multiple switching problem and application to investments in electricity generation," Papers 1210.8175, arXiv.org.
    5. Füss, Roland & Mahringer, Steffen & Prokopczuk, Marcel, 2013. "Electricity Spot and Derivatives Pricing when Markets are Interconnected," Working Papers on Finance 1323, University of St. Gallen, School of Finance.
    6. Coulon, Michael & Powell, Warren B. & Sircar, Ronnie, 2013. "A model for hedging load and price risk in the Texas electricity market," Energy Economics, Elsevier, vol. 40(C), pages 976-988.
    7. René Aid & Luciano Campi & Nicolas Langrené, 2010. "A structural risk-neutral model for pricing and hedging power derivatives," Working Papers hal-00525800, HAL.

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