Modelling the joint behaviour of electricity prices in interconnected markets. Issue 9 (1st September 2020)

• Record Type: Journal Article
• Authors: Christensen, Troels Sønderby; Benth, Fred Espen
• Is Part Of: Quantitative finance. Volume 20:Issue 9(2020)
• Page Start: 1441
• Page End: 1456
• Publication Date: 2020-09-01
• Subjects: Day-ahead electricity prices -- Interconnected markets -- Stochastic modelling -- Derivative pricing; C3 -- G1 -- Q4; Finance -- Periodicals; Business mathematics -- Periodicals; Finance -- Mathematical models -- Periodicals; Investments -- Mathematics -- Periodicals; Economics -- Periodicals; Finances -- Modèles mathématiques -- Périodiques; 332.015118
• DOI: 10.1080/14697688.2020.1733059
• Languages: English
• ISSNs: 1469-7688

Abstract

Abstract : The liberalization of energy markets worldwide during recent decades has introduced severe implications for the price formation in these markets. Especially within the European day-ahead electricity markets, increased physical connections between different market areas and a joint effort on optimizing the aggregate social welfare have led to highly connected markets. Consequently, observing the exact same hourly day-ahead prices for two or more interconnected electricity markets in Europe happens frequently. This affects the modelling of such prices and in turn the valuation of derivatives written on prices from these market areas. In this paper, we propose a joint model for day-ahead electricity prices in interconnected markets composed of a combination of transformed Ornstein–Uhlenbeck processes. We discuss the properties of the model and propose an estimation procedure based on filtering techniques. Furthermore, the properties of the model reveal that analytical prices are attainable for, e.g., forwards and spread options.