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Credit Value Adjustment and Economic Motivation to Trade on PXE

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  • Igor Paholok

Abstract

Electricity forward contracts can normally be traded in two ways in the Czech Republic: OTC forwards, which means bilaterally or bilaterally through a broker, and futures through the Power Exchange Central Europe. Each way has its own economic pros and cons. As the most crucial point, a counterparty risk and costs of funding are usually mentioned. Contracts traded on the power exchange bear less or no credit risk, as every deal is paired via central counterparty. On the other hand, the power exchange requires a margin deposit and daily profit and loss settlement which might increase funding costs. The fact that the counterparty risk is lower for exchange contracts with higher funding costs is well-known, but rarely quantified. We use the so-called Credit Value Adjustment concept in order to quantify the market value of the credit risk. We compare this value with potential funding costs. The aim of this paper is to compare both the OTC and exchange ways of trading using risk-adjusted economic characteristics.

Suggested Citation

  • Igor Paholok, 2015. "Credit Value Adjustment and Economic Motivation to Trade on PXE," Prague Economic Papers, Prague University of Economics and Business, vol. 2015(3), pages 245-259.
    • Handle: RePEc:prg:jnlpep:v:2015:y:2015:i:3:id:517:p:245-259
    DOI: 10.18267/j.pep.517
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    References listed on IDEAS

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    1. Alvaro Cartea & Marcelo Figueroa, 2005. "Pricing in Electricity Markets: A Mean Reverting Jump Diffusion Model with Seasonality," Applied Mathematical Finance, Taylor & Francis Journals, vol. 12(4), pages 313-335.
    2. Tomáš Horník & Ota Drahovzal, 2008. "Electro-energetics - managing new risks," Ekonomika a Management, Prague University of Economics and Business, vol. 2008(3).
    3. Jiří Witzany, 2017. "Credit Risk Management," Springer Books, Springer, number 978-3-319-49800-3, June.
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    Cited by:

    1. Jan Šedivý, 2019. "Optimální způsob sjednání derivátu za přítomnosti rizika protistrany [Optimal Method of Entering a Derivative Contract in the Presence of Counterparty Risk]," Politická ekonomie, Prague University of Economics and Business, vol. 2019(1), pages 65-81.

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    More about this item

    Keywords

    Wiener process; power futures; Merton model; futures margining; Credit Value Adjustment; counterparty risk;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • Q47 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy Forecasting
    • Q49 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Other

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