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Portfolio Optimization for Power Plants: The Impact of Credit Risk Mitigation and Margining

  • Lang, Joachim


    (E.ON AG, Controlling / Corporate Planning)

  • Madlener, Reinhard


    (E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN))

The aim of this study is to analyze the impact of credit risk mitigation via margining on the optimal portfolio selection for power plants. We develop a model to estimate margining cashflows that is based on the clearing framework of the European Commodity Clearing AG (ECC), on stochastic commodity price tracks, and on a pre-defined hedging strategy. To evaluate an assumed set of power plants, we calculate the discounted cashflow for each power plant in conjunction with a market model and a Monte Carlo simulation on commodity price tracks. The valuation of the power plants is done with and without credit risk mitigation by means of margining. The resulting differences in the values, with and without margining, are analyzed with the mean-variance portfolio approach of Markowitz, to specify the consequences of margining on the efficient frontier of possible power plant portfolios. We find that the consideration of margining for power plant portfolio selection is relevant, as it can markedly change the composition of efficient portfolios on the efficient frontier.

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Paper provided by E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN) in its series FCN Working Papers with number 11/2010.

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Length: 55 pages
Date of creation: Sep 2010
Date of revision:
Handle: RePEc:ris:fcnwpa:2010_011
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  1. Westner, Günther & Madlener, Reinhard, 2009. "Development of Cogeneration in Germany: A Dynamic Portfolio Analysis Based on the New Regulatory Framework," FCN Working Papers 4/2009, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN), revised Mar 2010.
  2. Lang, Joachim & Madlener, Reinhard, 2010. "Relevance of Risk Capital and Margining for the Valuation of Power Plants: Cash Requirements for Credit Risk Mitigation," FCN Working Papers 1/2010, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
  3. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
  4. Westner, Günther & Madlener, Reinhard, 2009. "The Benefit of Regional Diversification of Cogeneration Investments in Europe: A Mean-Variance Portfolio Analysis," FCN Working Papers 5/2009, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN), revised Mar 2010.
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  7. Madlener, Reinhard & Wenk, Christioph, 2008. "Efficient Investment Portfolios for the Swiss Electricity Supply Sector," FCN Working Papers 2/2008, E.ON Energy Research Center, Future Energy Consumer Needs and Behavior (FCN).
  8. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  9. Rockafellar, R. Tyrrell & Uryasev, Stanislav, 2002. "Conditional value-at-risk for general loss distributions," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1443-1471, July.
  10. Bar-Lev, Dan & Katz, Steven, 1976. "A Portfolio Approach to Fossil Fuel Procurement in the Electric Utility Industry," Journal of Finance, American Finance Association, vol. 31(3), pages 933-47, June.
  11. Ventosa, Mariano & Baillo, Alvaro & Ramos, Andres & Rivier, Michel, 2005. "Electricity market modeling trends," Energy Policy, Elsevier, vol. 33(7), pages 897-913, May.
  12. Muñoz, José Ignacio & Sánchez de la Nieta, Agustín A. & Contreras, Javier & Bernal-Agustín, José L., 2009. "Optimal investment portfolio in renewable energy: The Spanish case," Energy Policy, Elsevier, vol. 37(12), pages 5273-5284, December.
  13. Bennett, Paul, 1984. "Applying portfolio theory to global bank lending," Journal of Banking & Finance, Elsevier, vol. 8(2), pages 153-169, June.
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