IDEAS home Printed from https://ideas.repec.org/p/hhs/gunwpe/0101.html
   My bibliography  Save this paper

Does the Black-Scholes formula work for electricity markets? A nonparametric approach

Author

Listed:
  • Hjalmarsson, Erik

    () (Department of Economics, School of Economics and Commercial Law, Göteborg University)

Abstract

Despite the high volatilities recorded for electricity prices, there seems to be little demand for options on electricity. One reason for the disinterest in electricity options could arise from uncertainty about how to price these options. This study uses recent econometric advances to nonparametrically estimate correct prices for electricity options and compare these to the Black-Scholes prices. The main finding is that although the nonparametric estimates deviate significantly from the Black-Scholes prices, it would be diffcult to find an alternative parametric model that performs better. Thus, from a practical viewpoint, the Black-Scholes prices appear to be the best available.

Suggested Citation

  • Hjalmarsson, Erik, 2003. "Does the Black-Scholes formula work for electricity markets? A nonparametric approach," Working Papers in Economics 101, University of Gothenburg, Department of Economics.
    • Handle: RePEc:hhs:gunwpe:0101
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/2077/2809
    Download Restriction: no

    References listed on IDEAS

    as
    1. Ait-Sahalia, Yacine, 1996. "Testing Continuous-Time Models of the Spot Interest Rate," Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 385-426.
    2. A. Ronald Gallant & Chien-Te Hsu & George Tauchen, 1999. "Using Daily Range Data To Calibrate Volatility Diffusions And Extract The Forward Integrated Variance," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 617-631, November.
    3. Hardle, Wolfgang & Linton, Oliver, 1986. "Applied nonparametric methods," Handbook of Econometrics,in: R. F. Engle & D. McFadden (ed.), Handbook of Econometrics, edition 1, volume 4, chapter 38, pages 2295-2339 Elsevier.
    4. Knittel, Christopher R. & Roberts, Michael R., 2005. "An empirical examination of restructured electricity prices," Energy Economics, Elsevier, vol. 27(5), pages 791-817, September.
    5. Sanjiv R. Das, 1998. "Poisson-Guassian Processes and the Bond Markets," NBER Working Papers 6631, National Bureau of Economic Research, Inc.
    6. Federico M. Bandi & Peter C. B. Phillips, 2003. "Fully Nonparametric Estimation of Scalar Diffusion Models," Econometrica, Econometric Society, vol. 71(1), pages 241-283, January.
    7. Bandi, Federico & Moloche, Guillermo, 2008. "On the functional estimation of multivariate diffusion processes," MPRA Paper 43681, University Library of Munich, Germany.
    8. Hendrik Bessembinder & Michael L. Lemmon, 2002. "Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets," Journal of Finance, American Finance Association, vol. 57(3), pages 1347-1382, June.
    9. Ball, Clifford A. & Torous, Walter N., 1983. "A Simplified Jump Process for Common Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 18(01), pages 53-65, March.
    10. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
    11. Malcolm P. Baker & E. Scott Mayfield & John E. Parsons, 1998. "Alternative Models of Uncertain Commodity Prices for Use with Modern Asset Pricing Methods," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 115-148.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Twomey, P. & Neuhoff, K., 2005. "Market Power and Technological Bias: The Case of Electricity Generation," Cambridge Working Papers in Economics 0532, Faculty of Economics, University of Cambridge.
    2. Twomey, Paul & Neuhoff, Karsten, 2010. "Wind power and market power in competitive markets," Energy Policy, Elsevier, vol. 38(7), pages 3198-3210, July.

    More about this item

    Keywords

    Electricity markets; Nonparametric estimation; Option pricing;

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • L94 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Electric Utilities

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hhs:gunwpe:0101. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marie Andersson). General contact details of provider: http://edirc.repec.org/data/naiguse.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.