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Loss functions in regression models: Impact on profits and risk in day-ahead electricity trading

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  • Serafin, Tomasz
  • Weron, Rafał

Abstract

We study the impact of the loss function used to estimate the parameters of a regression-type model on profits and risk in day-ahead electricity trading. To provide practical insights, we consider a strategy that incorporates battery storage and includes realistic operating costs in the calculation of revenues. Using 2021-2024 data from the German market as the testing ground, we provide evidence that minimizing a loss function that combines absolute errors with a quadratic penalty for price spread predictions of the opposite sign is the preferred option. Forecasts based on the introduced directional loss function repeatedly and in the majority of cases yield trading decisions that outperform those based on predictions from models estimated using squared, absolute, percentage, or asymmetric losses, as measured by the Sharpe ratio and profits per trade.

Suggested Citation

  • Serafin, Tomasz & Weron, Rafał, 2025. "Loss functions in regression models: Impact on profits and risk in day-ahead electricity trading," Energy Economics, Elsevier, vol. 148(C).
    • Handle: RePEc:eee:eneeco:v:148:y:2025:i:c:s0140988325004207
    DOI: 10.1016/j.eneco.2025.108596
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    Keywords

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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices
    • Q47 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy Forecasting

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