TY - JOUR
T1 - A mixed C-vine copula model for hedging price and volumetric risk in wind power trading
AU - Pircalabu, Anca
AU - Jung, Jesper
PY - 2017
Y1 - 2017
N2 - When energy trading companies enter into long-term agreements with wind power producers, where a fixed price is paid for the fluctuating production, they are facing a joint price and volumetric risk. Since the pay-off of such agreements is non-linear, a hedging portfolio would ideally consist of not only forwards, but also a basket of e.g. call and put options. Illiquidity and an almost non-existent market for options challenge however the optimal hedging of joint price and volumetric risk in many market places. Here, we consider the case of the Danish power market, and exploit its strong positive correlation with the much more liquid German market to construct a proxy hedge. We propose a three-dimensional mixed vine copula to model the evolution of the Danish and German spot electricity prices and the Danish wind power production. We construct a realistic hedging portfolio by identifying various instruments available in the market, such as real options in the form of the right to transfer electricity across the border and the right to convert electricity to heat. Using the proposed vine copula to determine optimal hedging decisions, we show that significant benefits are to be drawn by extending the hedging portfolio with the proposed instruments.
AB - When energy trading companies enter into long-term agreements with wind power producers, where a fixed price is paid for the fluctuating production, they are facing a joint price and volumetric risk. Since the pay-off of such agreements is non-linear, a hedging portfolio would ideally consist of not only forwards, but also a basket of e.g. call and put options. Illiquidity and an almost non-existent market for options challenge however the optimal hedging of joint price and volumetric risk in many market places. Here, we consider the case of the Danish power market, and exploit its strong positive correlation with the much more liquid German market to construct a proxy hedge. We propose a three-dimensional mixed vine copula to model the evolution of the Danish and German spot electricity prices and the Danish wind power production. We construct a realistic hedging portfolio by identifying various instruments available in the market, such as real options in the form of the right to transfer electricity across the border and the right to convert electricity to heat. Using the proposed vine copula to determine optimal hedging decisions, we show that significant benefits are to be drawn by extending the hedging portfolio with the proposed instruments.
KW - Spot electricity prices
KW - Wind power production
KW - Mathematical finance
KW - Copula vines
KW - Energy derivatives
KW - Hedging
U2 - 10.1080/14697688.2017.1307511
DO - 10.1080/14697688.2017.1307511
M3 - Journal article
SN - 1469-7688
VL - 17
SP - 1583
EP - 1600
JO - Quantitative Finance
JF - Quantitative Finance
IS - 10
ER -