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

  • Katja Ignatieva EMAIL logo
Published/Copyright: November 14, 2013

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.


Corresponding author: Katja Ignatieva, School of Risk and Actuarial Studies, Australian School of Business, University of New South Wales, Kensington Campus, Sydney NSW 2052, Australia, Phone: (+61-2) 9385 6810, Fax: (+61-2) 9385 1883, e-mail:

Acknowledgment

We would like to thank Christian Schlag and Michael Sherris for their valuable comments and helpful suggestions.

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Published Online: 2013-11-14
Published in Print: 2014-12-1

©2014 by De Gruyter

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