Random movements of power prices in competitive markets: a hybrid model approach

ABSTRACT This paper shows that electricity price dynamics in deregulated markets can be described by modeling the movements of the power margin level in a stochastic environment. We present a regime-switching approach to capture the main characteristics of electricity price dynamics within a supply-demand context: in the presence of stable periods, in which prices fluctuate around some long-run mean, and during turbulent periods, in which prices experience jumps and short-lived spikes of very large magnitude. The proposed approach is flexible enough to incorporate shortages in electricity generation, forced outages and peaks in electricity demand. The empirical analysis, performed to estimate the model on market data by maximum likelihood, offers an interesting agreement with the properties of observed logreturn distributions.