Derivatives Use: Valuation and hedging of contingent claims on power with spikes: A non-Markovian approach
- PDF / 465,002 Bytes
- 26 Pages / 595.267 x 765.011 pts Page_size
- 70 Downloads / 245 Views
Practical applications As the power markets are becoming deregulated worldwide, the modelling of power prices with spikes is becoming a key problem in energy risk management, physical assets valuation and derivatives pricing. This paper presents and further develops the non-Markovian approach to modelling power prices with spikes proposed in earlier papers by the author. This approach allows for modelling spikes directly as self-reversing jumps which, in turn, allows for the parameters of spikes to be directly observable from market data. This approach also allows for a relatively simple pricing of contingent claims both on power with spikes and on forwards on power for power with spikes. Moreover, contingent claims on forwards on power for power with spikes can be dynamically hedged via the standard delta hedging. For example, European call and put options both on power with spikes and on forwards on power for power with spikes can be priced analytically via simple formulae similar to the Black–Scholes formulae for European call and put options. In turn, this approach also allows for a relatively simple valuation of physical assets such as power plants and transmission lines viewed as real options. Abstract A new approach to modelling spikes in power prices proposed in earlier papers by the author is presented and further developed. By contrast with the standard approaches, power prices with spikes
308
are modelled as a non-Markovian stochastic process that allows for modelling spikes directly as self-reversing jumps. It is also shown how this approach can be used to value and hedge European contingent claims on power with spikes.
Derivatives Use, Trading & Regulation V olume E leven Number Four 2006
Derivatives Use, Trading & Regulation, Vol. 11 No. 4, 2006, pp. 308–333 䉷 Palgrave Macmillan Ltd 1747–4426/06 $30.00
INTRODUCTION As the power markets are becoming deregulated worldwide, the modelling of spikes in power prices is becoming a key problem in energy risk management, physical assets valuation and derivatives pricing. This paper presents and further develops a new approach to modelling spikes in power prices proposed by the author in references 1–5. The main motivation for this approach is that, in the author’s opinion, different mechanisms should be responsible for the reversion of power prices to their-long term mean between spikes and for the reversion of power prices to their long-term mean during spikes — that is, for the decay of spikes. This is due to the substantial difference in the scales of the deviations of power prices from their long-term mean between spikes and during spikes. For example, power prices in the US Midwest in June 1998 rose to $7,500 per megawatt hour (MWh) compared with typical prices of around $30/MWh as a result of unseasonably hot weather, planned and unplanned outages and transmission constraints.6 By contrast with the standard approaches,6–9 this study models power prices with spikes as a non-Markovian stochastic process that allows for modelling spikes directly as se
Data Loading...
