Modeling Electricity Spot Prices - Combining Mean-Reversion, Spikes and Stochastic Volatility

European Journal of Finance, Forthcoming

Posted: 21 Feb 2011 Last revised: 24 Oct 2012

See all articles by Klaus Mayer

Klaus Mayer

Technische Universität München (TUM) - Center for Entrepreneurial and Financial Studies (CEFS)

Thomas Schmid

The University of Hong Kong - Faculty of Business and Economics

Florian Weber

Technische Universität München (TUM) - Center for Entrepreneurial and Financial Studies (CEFS)

Date Written: Septermber 10, 2012

Abstract

With the liberalization of electricity trading, the electricity market has grown rapidly over the last decade. However, while spot and future markets are currently rather liquid, option trading is still limited. One of the potential reasons for this is that the electricity spot price process remains a puzzle to researchers and practitioners. In this paper, we propose an approach to model electricity spot prices that combines mean reversion, spikes, negative prices, and stochastic volatility. Thereby, we use different mean reversion rates for normal and extreme (spike) periods. Furthermore, all model parameters can easily be estimated using historical data. Consequently, we argue that this model does not only extend academic literature on electricity spot price modeling, but is also suitable for practical purposes, such as an underlying price model for option pricing.

Keywords: Electricity, Energy markets, Lévy processes, Mean-reversion, Spikes, Stochastic volatility, GARCH

JEL Classification: G17

Suggested Citation

Mayer, Klaus and Schmid, Thomas and Weber, Florian, Modeling Electricity Spot Prices - Combining Mean-Reversion, Spikes and Stochastic Volatility (Septermber 10, 2012). European Journal of Finance, Forthcoming . Available at SSRN: https://ssrn.com/abstract=1763906 or http://dx.doi.org/10.2139/ssrn.1763906

Klaus Mayer (Contact Author)

Technische Universität München (TUM) - Center for Entrepreneurial and Financial Studies (CEFS) ( email )

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Munich, 80333
Germany
++49 89 289 25479 (Phone)
++49 89 289 25488 (Fax)

Thomas Schmid

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Florian Weber

Technische Universität München (TUM) - Center for Entrepreneurial and Financial Studies (CEFS) ( email )

Arcisstraße 21
München, 80333
Germany
++49 89 289 25479 (Phone)
++49 89 289 25488 (Fax)

HOME PAGE: http://www.cefs.de

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