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A nonparametric model for spot price dynamics and pricing of futures contracts in electricity markets

A nonparametric model for spot price dynamics and pricing of futures contracts in electricity... Abstract This paper deals with the estimation of continuous time diffusion processes describing the dynamics of electricity spot prices. Different parametric models have been proposed in the literature, each attempting to capture empirical characteristics and stylized facts of the electricity market like the spiky behavior of the spot prices. Although jump-diffusion and regime-switching models perform reasonably well, there is always a trade-off between model parsimony and adequacy. The results in the literature indicate that none of the models seem to consistently outperform its counterparts. This paper avoids making parametric assumption about the drift and the diffusion coefficient functions of the underlying electricity spot prices, and estimates these functions together with the market price of risk in a nonparametric way. The latter allows us to price futures contracts written on electricity spots. Using electricity spot prices and futures data from the regional electricity markets in Australia, we show that besides offering a convenient way of estimating the continuous-time models for electricity spot prices, our nonparametric estimation procedure performs well in- and out-of-sample when dealing with pricing of future contracts. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Studies in Nonlinear Dynamics & Econometrics de Gruyter

A nonparametric model for spot price dynamics and pricing of futures contracts in electricity markets

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Publisher
de Gruyter
Copyright
Copyright © 2014 by the
ISSN
1081-1826
eISSN
1558-3708
DOI
10.1515/snde-2012-0001
Publisher site
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Abstract

Abstract This paper deals with the estimation of continuous time diffusion processes describing the dynamics of electricity spot prices. Different parametric models have been proposed in the literature, each attempting to capture empirical characteristics and stylized facts of the electricity market like the spiky behavior of the spot prices. Although jump-diffusion and regime-switching models perform reasonably well, there is always a trade-off between model parsimony and adequacy. The results in the literature indicate that none of the models seem to consistently outperform its counterparts. This paper avoids making parametric assumption about the drift and the diffusion coefficient functions of the underlying electricity spot prices, and estimates these functions together with the market price of risk in a nonparametric way. The latter allows us to price futures contracts written on electricity spots. Using electricity spot prices and futures data from the regional electricity markets in Australia, we show that besides offering a convenient way of estimating the continuous-time models for electricity spot prices, our nonparametric estimation procedure performs well in- and out-of-sample when dealing with pricing of future contracts.

Journal

Studies in Nonlinear Dynamics & Econometrics – de Gruyter

Published: Dec 1, 2014

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    Longstaff
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    Lucia
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    Geman
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    Jiang
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    De Jong
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    Sheather
  • Testing Continuous - Time Models of the Spot Interest Rate of
    Sahalia
  • Stable Modeling of Different European Markets Investment Management and Financial Innovations
    Mugele
  • Brief Survey of Band - Width Selection for Density Estimation of American Statistical
    Jones
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    Künsch
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    Haldrup
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    Kosater
  • Managing Price Risk Risk
    Kaminski
  • On Estimating the Diffusion Coeffcient from Discrete Observations of
    Florens
  • a Nonparametric Pricing of Interest Rate Derivative Securities
    Sahalia
  • Nonparametric Model of Term Structure Dynamics and the Market Price of Interest Rate Risk of
    Stanton
  • The Stochastic Behavior of Commodity Prices : Implications for Valuation and Hedging The of
    Schwartz
  • Modeling and Forecasting Loads and Prices in Deregulated Electricity Markets ARE
    Weron
  • An Empirical Comparison of Alternate Regime - Switching Models for Electricity Spot Prices
    Janczura
  • Derivatives Pricing Risk Publications
    Clewlow
  • Estimating the Commodity Market Price of Risk for Prices
    Kolos
  • Risk
    Eydeland
  • De Option Formulas for Mean - Reverting Power Prices with Risk Management
    Huisman
  • Asymptotic Inference about Predictive Ability
    West
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    Haldrup
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    Øksendal
  • Nonparametric Model of Term Structure Dynamics and the Market Price of Interest Rate Risk of
    Stanton
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    Roberts
  • Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets of
    Bessembinder
  • The Influence of Temperature on Spike Probability in Day - Ahead Power Prices
    Huisman
  • Asymptotic Inference about Predictive Ability
    West
  • Financial Problems Models Princeton Princeton University
    Gourieroux
  • Nonparametric Estimates of Multivariate Probability Density Theory of Probability and Applications
    Epanechnikov
  • Stochastic An Introduction with Applications New York Springer Verlag
    Øksendal
  • The Long Run of Prices The
    Pindyck
  • Measuring Anti - Correlations in the Nordic Electricity Spot Market by Wavelets
    Simonsen
  • Bierbrauer a Modeling Electricity Prices Diffusion and Regime Switching
    Weron
  • Modeling Highly Volatile and Seasonal Markets : Evidence from the Nord Pool Electricity Market The Application of Proceedings of the Second Nikkei
    Weron
  • Bierbrauer Spot and Derivative Pricing in the Market of
    Menn
  • Knittel An Empirical Examination of Deregulated Electricity Prices Working Paper
    Roberts
  • Reliable Data - Based Bandwidth Selection Method for Kernel Density Estimation of the
    Sheather
  • Non - Parametric Kernel Estimation of the Coeffcient of a Diffusion of
    Jacod
  • Pricing in Electricity Markets : a Mean Reverting Jump Diffusion Model with Seasonality
    Cartea
  • On Transition Probabilities of Regime Switching in Electricity Prices
    Kanamura
  • Can Markov Regime - Switching Models Improve Power - Price Forecasts Evidence from German Prices
    Kosater
  • Measuring Anti - Correlations in the Nordic Electricity Spot Market by Wavelets
    Simonsen
  • Stochastic Price Modeling of High Volatility Mean - Reverting Spike - Prone Commodities : The Australian Wholesale Spot Electricity Market
    Higgs
  • On Transition Probabilities of Regime Switching in Electricity Prices
    Kanamura
  • The Long Run of Prices The
    Pindyck
  • Wand Kernel Smoothing
    Jones
  • Nonparametric Estimation of the Diffusion Coeffcient of a Diffusion Process Stochastic Analysis and
    Soulier