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Pricing electricity derivatives within a Markov regime-switching model: a risk premium approach

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  • Joanna Janczura
Abstract
In this paper we derive analytic formulas for electricity derivatives under assumption that electricity spot prices follow a 3-regime Markov regime-switching model with independent spikes and drops and periodic transition matrix. Since the classical derivatives pricing methodology cannot be used in the case of non-storable commodities, we employ the concept of the risk premium. The obtained theoretical results are then used for the European Energy Exchange data analysis. We calculate the risk premium in the case of the calibrated 3-regime MRS model. We find a time varying structure of the risk premium and an evidence for a negative risk premium (or positive forward premium), especially at short times before delivery. Finally, we use the obtained risk premium to calculate prices of European options written on spot, as well as, forward prices. Copyright The Author(s) 2014

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  • Joanna Janczura, 2014. "Pricing electricity derivatives within a Markov regime-switching model: a risk premium approach," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 79(1), pages 1-30, February.
    • Handle: RePEc:spr:mathme:v:79:y:2014:i:1:p:1-30
    DOI: 10.1007/s00186-013-0451-8
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    4. Weron, Rafał, 2014. "Electricity price forecasting: A review of the state-of-the-art with a look into the future," International Journal of Forecasting, Elsevier, vol. 30(4), pages 1030-1081.
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