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Modelling electricity prices by the potential jump-diffusion

In: Stochastic Finance

Author

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  • Svetlana Borovkova

    (Delft University of Technology)

  • Ferry Jaya Permana

    (Delft University of Technology)

Abstract

Summary In liberalized electricity markets prices exhibit features, such as price spikes, rarely seen in other commodity markets. Models for electricity spot price, such as mean-reverting jump-diffusions and regime-switching models are only partially successful in modelling price spikes. In this paper we introduce a new approach to electricity price modelling: a potential function jump-diffusion model, which allows for a continuously varying mean-reversion rate and provides a flexible way to model price spikes. We analyze electricity spot prices from three major European power exchanges: Amsterdam Power Exchange, UK Power Exchange and European Power Exchange (Germany). The potential function jump-diffusion model is applied to the historical spot prices from these exchanges, and its performance is compared to that of the mean-reverting jump-diffusion. The potential function approach is able to capture price spike behavior and overall characteristics of the data remarkably well, and generally better than traditional mean-reverting models. This approach allows for a continuum of different reversion rates, and hence provides a richer model structure and significantly extends the regime-switching model of Huisman and Mahieu [13].

Suggested Citation

  • Svetlana Borovkova & Ferry Jaya Permana, 2006. "Modelling electricity prices by the potential jump-diffusion," Springer Books, in: A. N. Shiryaev & M. R. Grossinho & P. E. Oliveira & M. L. Esquível (ed.), Stochastic Finance, chapter 9, pages 239-263, Springer.
    • Handle: RePEc:spr:sprchp:978-0-387-28359-3_9
    DOI: 10.1007/0-387-28359-5_9
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