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A Lattice-Based Method for Pricing Electricity Derivatives Under the Threshold Model

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  • Helyette Geman
  • Stelios Kourouvakalis

Abstract

Of the several models introduced for the modelling of electricity prices, the one proposed by Geman and Roncoroni, that we will refer to as the 'threshold model', has exhibited significant success in both its statistical properties and ability to accurately replicate trajectories of electricity prices. This article presents a lattice-based method for the discretization of the threshold model that allows for the pricing of derivatives, including swing options. The methodology builds on an idea presented by Bally et al. for discretizing density functions, and constructs an approximating process that is shown to be a good proxy of the original process, producing a grid that incorporates both mean reversion and jumps.

Suggested Citation

  • Helyette Geman & Stelios Kourouvakalis, 2008. "A Lattice-Based Method for Pricing Electricity Derivatives Under the Threshold Model," Applied Mathematical Finance, Taylor & Francis Journals, vol. 15(5-6), pages 531-567.
  • Handle: RePEc:taf:apmtfi:v:15:y:2008:i:5-6:p:531-567
    DOI: 10.1080/13504860802379835
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    References listed on IDEAS

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    1. Albanese, Claudio & Lo, Harry & Stathis, Tompaidis, 2006. "A Numerical Method for Pricing Electricity Derivatives for Jump-Diffusion Processes Based on Continuous Time Lattices," MPRA Paper 5245, University Library of Munich, Germany.
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    Cited by:

    1. Benth, Fred Espen & Kiesel, RĂ¼diger & Nazarova, Anna, 2012. "A critical empirical study of three electricity spot price models," Energy Economics, Elsevier, vol. 34(5), pages 1589-1616.

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