Speculative Trading of Electricity Contracts in Interconnected Locations

33 Pages Posted: 17 Nov 2016

See all articles by Álvaro Cartea

Álvaro Cartea

University of Oxford; University of Oxford - Oxford-Man Institute of Quantitative Finance

Sebastian Jaimungal

University of Toronto - Department of Statistics

Zhen Qin

University of Toronto - Department of Statistics

Date Written: November 16, 2016

Abstract

We derive an investor’s optimal trading strategy of electricity contracts traded in two locations joined by an interconnector. The investor employs a price model which includes the impact of her own trades. The investor’s trades have a permanent impact on prices because her trading activity affects the demand of contracts in both locations. Additionally, the investor receives prices which are worse than the quoted prices as a result of the elasticity of liquidity provision of contracts. Furthermore, the investor is ambiguity averse, so she acknowledges that her model of prices may be misspecified and considers other models when devising her trading strategy. We show that as the investor’s degree of ambiguity aversion increases, her trading activity decreases in both locations, and thus her inventory exposure also decreases. Finally, we show that there is a range of ambiguity aversion parameters where the Sharpe ratio of the trading strategy increases when ambiguity aversion increases.

Keywords: Ambiguity Aversion, Model Uncertainty, Electricity Interconnector, Statistical Arbitrage

Suggested Citation

Cartea, Álvaro and Jaimungal, Sebastian and Qin, Zhen, Speculative Trading of Electricity Contracts in Interconnected Locations (November 16, 2016). Available at SSRN: https://ssrn.com/abstract=2870814 or http://dx.doi.org/10.2139/ssrn.2870814

Álvaro Cartea (Contact Author)

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

Sebastian Jaimungal

University of Toronto - Department of Statistics ( email )

100 St. George St.
Toronto, Ontario M5S 3G3
Canada

HOME PAGE: http://http:/sebastian.statistics.utoronto.ca

Zhen Qin

University of Toronto - Department of Statistics ( email )

Toronto, Ontario M5S 3G8
Canada

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