Inverse Optimization for the Recovery of Market Structure from Market Outcomes: An Application to the MISO Electricity Market

Operations Research, Forthcoming

42 Pages Posted: 31 May 2015 Last revised: 18 May 2017

See all articles by John R. Birge

John R. Birge

University of Chicago - Booth School of Business

Ali Hortacsu

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER)

Michael Pavlin

Wilfrid Laurier University - School of Business & Economics

Date Written: January 30, 2017

Abstract

We propose an inverse optimization based methodology to determine market structure from commodity and transportation prices. The methods are appropriate for locational marginal price based electricity markets where prices are shadow prices in the centralized optimization used to clear the market. We apply the inverse optimization methodology to outcome data from the Midcontinent ISO electricity market (MISO) and, under noise-free assumptions, recover parameters of transmission and related constraints that are not revealed to market participants but explain the price variation. We demonstrate and evaluate analytical uses of the recovered structure including reconstruction of the pricing mechanism and investigations of locational market power through the transmission constrained residual demand derivative. Prices generated from the reconstructed mechanism are highly correlated to actual MISO prices under a wide variety of market conditions. In a case study, the residual demand derivative is shown to be correlated with coefficients of certain transmission constraints.

Keywords: Inverse optimization, deregulated electricity markets

Suggested Citation

Birge, John R. and Hortacsu, Ali and Pavlin, Michael, Inverse Optimization for the Recovery of Market Structure from Market Outcomes: An Application to the MISO Electricity Market (January 30, 2017). Operations Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2612234 or http://dx.doi.org/10.2139/ssrn.2612234

John R. Birge

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Ali Hortacsu

University of Chicago - Department of Economics ( email )

1126 East 59th Street
Chicago, IL 60637
United States
773-702-5841 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Michael Pavlin (Contact Author)

Wilfrid Laurier University - School of Business & Economics ( email )

Waterloo, Ontario N2L 3C5
CANADA

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