TY - UNPB
T1 - Modeling the exact convergence of electricity prices in interconnected markets
AU - Christensen, Troels Sønderby
AU - Benth, Fred Espen
PY - 2019/1/11
Y1 - 2019/1/11
N2 - The liberalization of energy markets worldwide during recent decades has introduced severe implications on 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 - exact price convergence - for two or more interconnected electricity markets in Europe happens frequently, which affects the modeling of such prices and in turn the valuation of derivatives written on prices from such interconnected market areas. In this paper, we propose a continuous-time model that takes this feature into account in a reduced-form manner. We discuss the properties of the model and propose an estimation procedure. Furthermore, the properties of the model reveals that analytical prices are attainable for e.g. forwards and spread options.
AB - The liberalization of energy markets worldwide during recent decades has introduced severe implications on 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 - exact price convergence - for two or more interconnected electricity markets in Europe happens frequently, which affects the modeling of such prices and in turn the valuation of derivatives written on prices from such interconnected market areas. In this paper, we propose a continuous-time model that takes this feature into account in a reduced-form manner. We discuss the properties of the model and propose an estimation procedure. Furthermore, the properties of the model reveals that analytical prices are attainable for e.g. forwards and spread options.
U2 - 10.2139/ssrn.3312602
DO - 10.2139/ssrn.3312602
M3 - Working paper
BT - Modeling the exact convergence of electricity prices in interconnected markets
PB - SSRN: Social Science Research Network
ER -