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Pricing electricity risk by interest rate methods

Author

Listed:
  • Juri Hinz
  • Lutz Von Grafenstein
  • Michel Verschuere
  • Martina Wilhelm

Abstract

We address a method for pricing electricity contracts based on the valuation of the ability to produce power, which is considered as the true underlying factor for electricity derivatives. This approach shows that an evaluation of free production capacity provides a framework where a change-of-numeraire transformation converts the electricity forward market into the common settings for money market modelling. Using the toolkit of interest rate theory, we derive explicit option pricing formulas.

Suggested Citation

  • Juri Hinz & Lutz Von Grafenstein & Michel Verschuere & Martina Wilhelm, 2005. "Pricing electricity risk by interest rate methods," Quantitative Finance, Taylor & Francis Journals, vol. 5(1), pages 49-60.
    • Handle: RePEc:taf:quantf:v:5:y:2005:i:1:p:49-60
    DOI: 10.1080/14697680500040876
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    References listed on IDEAS

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    1. Björk, Tomas, 1996. "Interest Rate Theory - CIME Lectures 1996," SSE/EFI Working Paper Series in Economics and Finance 133, Stockholm School of Economics.
    2. E. J. Anderson & A. B. Philpott, 2002. "Optimal Offer Construction in Electricity Markets," Mathematics of Operations Research, INFORMS, vol. 27(1), pages 82-100, February.
    3. Les Clewlow & Chris Strickland, 1999. "Valuing Energy Options in a One Factor Model Fitted to Forward Prices," Research Paper Series 10, Quantitative Finance Research Centre, University of Technology, Sydney.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Fanelli, Viviana & Maddalena, Lucia & Musti, Silvana, 2016. "Modelling electricity futures prices using seasonal path-dependent volatility," Applied Energy, Elsevier, vol. 173(C), pages 92-102.
    2. Joanna Janczura & Aleksander Weron, 2008. "Modelling energy forward prices," HSC Research Reports HSC/08/03, Hugo Steinhaus Center, Wroclaw University of Technology.
    3. Deschatre, Thomas & Féron, Olivier & Gruet, Pierre, 2021. "A survey of electricity spot and futures price models for risk management applications," Energy Economics, Elsevier, vol. 102(C).
    4. Kanamura, Takashi & Bunn, Derek W., 2022. "Market making and electricity price formation in Japan," Energy Economics, Elsevier, vol. 107(C).
    5. Olivier Féron & Pierre Gruet & Marc Hoffmann, 2020. "Efficient volatility estimation in a two‐factor model," Scandinavian Journal of Statistics, Danish Society for Theoretical Statistics;Finnish Statistical Society;Norwegian Statistical Association;Swedish Statistical Association, vol. 47(3), pages 862-898, September.
    6. Hess, Markus, 2017. "Modeling positive electricity prices with arithmetic jump-diffusions," Energy Economics, Elsevier, vol. 67(C), pages 496-507.
    7. Markus Hess, 2020. "Pricing electricity forwards under future information on the stochastic mean-reversion level," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 43(2), pages 751-767, December.
    8. Hinderks, W.J. & Wagner, A., 2020. "Factor models in the German electricity market: Stylized facts, seasonality, and calibration," Energy Economics, Elsevier, vol. 85(C).
    9. Rudiger Kiesel & Gero Schindlmayr & Reik Borger, 2009. "A two-factor model for the electricity forward market," Quantitative Finance, Taylor & Francis Journals, vol. 9(3), pages 279-287.
    10. Wieger Hinderks & Andreas Wagner & Ralf Korn, 2018. "A structural Heath-Jarrow-Morton framework for consistent intraday, spot, and futures electricity prices," Papers 1803.08831, arXiv.org, revised Jan 2019.
    11. Wieger Hinderks & Ralf Korn & Andreas Wagner, 2020. "Unifying the theory of storage and the risk premium by an unobservable intrinsic electricity price," Papers 2011.03987, arXiv.org.
    12. Fred Espen Benth & Marco Piccirilli & Tiziano Vargiolu, 2017. "Additive energy forward curves in a Heath-Jarrow-Morton framework," Papers 1709.03310, arXiv.org, revised Jun 2018.
    13. Thomas Deschatre & Olivier F'eron & Pierre Gruet, 2021. "A survey of electricity spot and futures price models for risk management applications," Papers 2103.16918, arXiv.org, revised Jul 2021.
    14. Fred Espen Benth & Jūratė Šaltytė Benth & Steen Koekebakker, 2008. "Stochastic Modeling of Electricity and Related Markets," World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 6811, August.
    15. Juri Hinz, 2006. "Valuing virtual production capacities on flow commodities," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 64(2), pages 187-209, October.
    16. Juri Hinz & Tanya Tarnopolskaya & Jeremy Yee, 2020. "Efficient algorithms of pathwise dynamic programming for decision optimization in mining operations," Annals of Operations Research, Springer, vol. 286(1), pages 583-615, March.

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