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Pricing electricity day-ahead cap futures with multifactor skew-t densities

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  • Takuji Matsumoto
  • Derek Bunn
  • Yuji Yamada

Abstract

Short-term risk management is becoming increasingly significant in power trading as the intermittent renewable generators introduce more weather risk into the price formation dynamics. There is a vacuum in hedging instruments at the day-ahead stage to protect retailers in particular from such volatility and price spikes. Motivated by this requirement, this paper analyses a flexible hedging product, day-ahead cap futures. For pricing this product, we parametrically predict the probability distribution of day-ahead prices using the multifactor Generalized Additive Model for Location, Scale and Shape (GAMLSS) based upon the skew-t distribution with weather forecasts and calendar information as explanatory variables. In particular, we reveal that this higher-order moment model is superior to several lower-order models such as the normal distribution in all the following three aspects: fairness as pricing method, underwriting risk of the risk-taker and the variance reduction effect of the risk hedger.

Suggested Citation

  • Takuji Matsumoto & Derek Bunn & Yuji Yamada, 2022. "Pricing electricity day-ahead cap futures with multifactor skew-t densities," Quantitative Finance, Taylor & Francis Journals, vol. 22(5), pages 835-860, May.
    • Handle: RePEc:taf:quantf:v:22:y:2022:i:5:p:835-860
    DOI: 10.1080/14697688.2021.1984553
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    Cited by:

    1. Armin Pourkhanali & Peyman Khezr & Rabindra Nepal & Tooraj Jamasb, 2023. "Fuel Price Caps in the Australian National Wholesale Electricity Market," CAMA Working Papers 2023-39, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    2. Mosquera-López, Stephania & Uribe, Jorge M., 2022. "Pricing the risk due to weather conditions in small variable renewable energy projects," Applied Energy, Elsevier, vol. 322(C).

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