Electricity futures price modeling with Lévy term structure models

Biagini, Francesca ; Bregman, Julia and Meyer-Brandis, Thilo (2015): Electricity futures price modeling with Lévy term structure models. In: International Journal of Theoretical and Applied Finance, Vol. 18, No. 01, 1550003

Abstract

In this paper, we generalize the approach of Hinz & Wilhelm (2006), Pricing flow commodity derivatives using fixed income market techniques. International Journal of Theoretical and Applied Finance 9, 1299–1321, replacing in the dynamics of the asset prices the Brownian motion by a more general Lévy process, also taking into account the occurrence of spikes. In particular, we reduce the modeling of an electricity futures market to the modeling of a Lévy bond market with an additional risky asset. This allows to employ well established techniques from interest rate term structure modeling. We then examine Markovianity of the induced electricity spot price, an important property when it comes to option pricing. We show that the considered method combined with the Fourier transform techniques provides semi analytic pricing formulas for European electricity options. Finally, we consider the pricing of path dependent derivatives such as electricity swing options.

• Item Type: Journal article
• Faculties: Mathematics, Computer Science and Statistics > Mathematics > Workgroup Financial Mathematics
• Subjects: 500 Science > 510 Mathematics
• ISSN: 0219-0249
• Language: English