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A Structural Risk-Neutral Model for Pricing and Hedging Power Derivatives

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Date
2013
Link to item file
http://hal.archives-ouvertes.fr/hal-00525800/fr/
Dewey
Economie financière
Sujet
extended incomplete Goodwin–Staton integral; spread options; power derivatives; minimal martingale measure; local risk minimization; scarcity function; electricity demand; capacity; fuels; Electricity spot and forward prices
JEL code
G1; Q41
Journal issue
Mathematical Finance
Volume
23
Number
3
Publication date
2013
Article pages
387-438
Publisher
Wiley
DOI
http://dx.doi.org/10.1111/j.1467-9965.2011.00507.x
URI
https://basepub.dauphine.fr/handle/123456789/11500
Collections
  • CEREMADE : Publications
Metadata
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Author
Langrené, Nicolas
Campi, Luciano
Aïd, René
Type
Article accepté pour publication ou publié
Abstract (EN)
We develop a structural risk-neutral model for energy market modifying along several directions the approach introduced in Aïd et al. In particular, a scarcity function is introduced to allow important deviations of the spot price from the marginal fuel price, producing price spikes. We focus on pricing and hedging electricity derivatives. The hedging instruments are forward contracts on fuels and electricity. The presence of production capacities and electricity demand makes such a market incomplete. We follow a local risk minimization approach to price and hedge energy derivatives. Despite the richness of information included in the spot model, we obtain closed-form formulae for futures prices and semiexplicit formulae for spread options and European options on electricity forward contracts. An analysis of the electricity price risk premium is provided showing the contribution of demand and capacity to the futures prices. We show that when far from delivery, electricity futures behave like a basket of futures on fuels.

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