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Efficient estimation of Markov regime-switching models: An application to electricity spot prices

  • Joanna Janczura
  • Rafal Weron

In this paper we discuss the calibration of models built on mean-reverting processes combined with Markov regime-switching (MRS). We propose a method that greatly reduces the computational burden induced by the introduction of independent regimes and perform a simulation study to test its efficiency. Our method allows for a 100 to over 1000 times faster calibration than in case of a competing approach utilizing probabilities of the last 10 observations. It is also more general and admits any value of gamma in the base regime dynamics. Since the motivation for this research comes from a recent stream of literature in energy economics, we apply the new method to sample series of electricity spot prices from the German EEX and Australian NSW markets. The proposed MRS models fit these datasets well and replicate the major stylized facts of electricity spot price dynamics.

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File URL: http://www.im.pwr.wroc.pl/~hugo/RePEc/wuu/wpaper/HSC_11_02.pdf
File Function: Original version, 2011
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Paper provided by Hugo Steinhaus Center, Wroclaw University of Technology in its series HSC Research Reports with number HSC/11/02.

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Length: 24 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:wuu:wpaper:hsc1102
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