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On Forward Price Modeling In Power Markets

In: Alternative Investments And Strategies

Author

Listed:
  • FRED ESPEN BENTH

    (Centre of Mathematics for Applications, University of Oslo, P.O. Box 1053, Blindern, 0316 Oslo, Norway and University of Agder, School of Management, Serviceboks 422, 4604 Kristiansand, Norway)

Abstract

Power forward contracts deliver electricity over a specified period, and can be viewed as a portfolio of forwards with maturity at each time instant in the delivery period. We investigate the implied power forward dynamics from a geometric Brownian motion specification of the forward price, which turns out to have a very complicated structure. Lognormal approximations are argued for, and we demonstrate that they work excellently in many situations. In particular, we focus on the approximation suggested by Bjerksund et al. [8], where the volatility of the power forward is simply the average of the fixed maturity forward volatility. Although giving a superior model to the moment matched dynamics, it fails to estimate the tails of the power forward distribution in some cases with extreme volatility and mean-reversion. We provide analytical bounds in terms of geometric Brownian motions for the power forward dynamics, and also compare the covariance structure with those implied by a geometric Brownian motion.

Suggested Citation

  • Fred Espen Benth, 2010. "On Forward Price Modeling In Power Markets," World Scientific Book Chapters, in: Rüdiger Kiesel & Matthias Scherer & Rudi Zagst (ed.), Alternative Investments And Strategies, chapter 5, pages 93-122, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789814280112_0005
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