A New Approach to Characterizing and Forecasting Electricity Price Volatility

Posted: 9 Aug 2009

See all articles by Kam Fong Chan

Kam Fong Chan

The University of Western Australia; Financial Research Network (FIRN)

Philip Gray

Department of Banking and Finance, Monash University

Bart van Campen

University of Auckland - Department of Economics

Date Written: August 7, 2009

Abstract

There is a growing need to model the dynamics of electricity spot prices. While many studies have adopted the jump-diffusion model used successfully in traditional financial markets, the distinctive features of energy prices present non-trivial challenges. In particular, electricity price series feature extreme jumps of magnitudes rarely seen in financial markets, and occurring at greater frequency. Standard parametric approaches to estimating jump-diffusion models struggle to disentangle the jump and non-jump variation. This paper explores a recently-developed approach to separating the total variation into jump and non-jump components. Using quadratic variation theory, we non-parametrically estimate jump parameters for five power markets which are known to feature some important physical differences. The unique characteristics of the jump and non-jump components of the total variation are studied for each market. Given the evidence that the two sources of variation in spot prices have distinct dynamics, the paper explores whether volatility forecasts can be improved by explicitly incorporating the jump and non-jump components of the total variation.

Keywords: Realized volatility, Bipower variation, Quadratic variation, Jumps, Volatility forecast

JEL Classification: C14, C53, G10

Suggested Citation

Chan, Kam Fong and Gray, Philip and van Campen, Bart, A New Approach to Characterizing and Forecasting Electricity Price Volatility (August 7, 2009). International Journal of Forecasting, Vol. 24, No. 4, 2008. Available at SSRN: https://ssrn.com/abstract=1445233

Kam Fong Chan (Contact Author)

The University of Western Australia ( email )

35 Stirling Highway
Crawley, Western Australia 6009
Australia

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Philip Gray

Department of Banking and Finance, Monash University ( email )

Building H
Caulfield, Victoria 3141
Australia

Bart Van Campen

University of Auckland - Department of Economics ( email )

Private Bag 92019
Auckland
New Zealand

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