Portfolio Optimization for Power Plants: The Impact of Credit Risk Mitigation and Margining
FCN Working Paper No. 11/2010
59 Pages Posted: 28 Sep 2010
Date Written: September 1, 2010
The aim of this study is to analyze the impact of credit risk mitigation via margining on the optimal portfolio selection for power plants. We develop a model to estimate margining cashflows that is based on the clearing framework of the European Commodity Clearing AG (ECC), on stochastic commodity price tracks, and on a pre-defined hedging strategy. To evaluate an assumed set of power plants, we calculate the discounted cashflow for each power plant in conjunction with a market model and a Monte Carlo simulation on commodity price tracks. The valuation of the power plants is done with and without credit risk mitigation by means of margining. The resulting differences in the values, with and without margining, are analyzed with the mean-variance portfolio approach of Markowitz, to specify the consequences of margining on the efficient frontier of possible power plant portfolios. We find that the consideration of margining for power plant portfolio selection is relevant, as it can markedly change the composition of efficient portfolios on the efficient frontier.
Keywords: Margin@Risk, Credit Risk Mitigation, Margining, Collateralization, Risk Capital, Power Plant Valuation, Portfolio Optimization, Cashflow Planning
JEL Classification: G11, G17, G32, L94, O16
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