Modeling the exact convergence of electricity prices in interconnected markets

Research output: Contribution to journalJournal articleResearchpeer-review

Abstract

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.
Original languageEnglish
JournalEnergy Economics
Number of pages19
ISSN0140-9883
Publication statusSubmitted - 2019

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Electricity
Derivatives
Power markets
Modeling
Electricity price
Electricity market

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Christensen, T. S., & Benth, F. E. (2019). Modeling the exact convergence of electricity prices in interconnected markets. Manuscript submitted for publication.
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Modeling the exact convergence of electricity prices in interconnected markets. / Christensen, Troels Sønderby; Benth, Fred Espen.

In: Energy Economics, 2019.

Research output: Contribution to journalJournal articleResearchpeer-review

TY - JOUR

T1 - Modeling the exact convergence of electricity prices in interconnected markets

AU - Christensen, Troels Sønderby

AU - Benth, Fred Espen

PY - 2019

Y1 - 2019

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.

M3 - Journal article

JO - Energy Economics

JF - Energy Economics

SN - 0140-9883

ER -