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Liquidity risks on power exchanges

Author

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  • DE MAERE D’AERTRYCKE, Gauthier

    (Université catholique de Louvain, CORE and INMA, B-1348 Louvain-la-Neuve, Belgium)

  • SMEERS, Yves

    (Université catholique de Louvain, CORE and INMA, B-1348 Louvain-la-Neuve, Belgium)

Abstract

Financial derivatives are important hedging tool for asset’s manager. Electricity is by its very nature the most volatile commodity, which creates big incentive to share the risk among the market participants through financial contracts. But, even if volume of derivatives contracts traded on Power Exchanges has been growing since the beginning of the restructuring of the sector, electricity markets continue to be considerably less liquid than other commodities. This paper tries to quantify the effect of this insufficient liquidity on power exchange, by introducing a pricing equilibrium model for power derivatives where agents can not hedge up to their desired level. Mathematically, the problem is a two stage stochastic Generalized Nash Equilibrium and its solution is not unique. Computing a large panel of solutions, we show how the risk premium and player’s profit are affected by the illiquidity.

Suggested Citation

  • DE MAERE D’AERTRYCKE, Gauthier & SMEERS, Yves, 2010. "Liquidity risks on power exchanges," LIDAM Discussion Papers CORE 2010005, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    • Handle: RePEc:cor:louvco:2010005
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    File URL: https://sites.uclouvain.be/core/publications/coredp/coredp2010.html
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    More about this item

    Keywords

    illiquidity; electricity; power exchange; artitrage; generalized Nash Equilibrium; equilibrium based model; coherent risk valuation;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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