Modelling Electricity Swaps with Stochastic Forward Premium Models

The Energy Journal, Forthcoming

76 Pages Posted: 20 Dec 2016 Last revised: 15 May 2017

Iván Blanco

CUNEF

Juan Ignacio Peña

Universidad Carlos III de Madrid - Department of Business Administration

Rosa Rodríguez

Universidad Carlos III de Madrid - Department of Business Administration

Date Written: December 18, 2016

Abstract

We present a new model for pricing electricity swaps. Two general factors affect all contracts but unique risk factors affect each contract. General factors are average swap prices and deterministic trend-seasonal components, and unique factors are forward premiums. Innovations follow MNIG distributions. We estimate the model with data from the European Energy Exchange. The model outperforms four competitors, both in in-sample valuation and in out-of-sample forecasting, and in fitting the term structure of volatilities by market segments. Competitor models are (i) diffusion spot prices, (ii) jump-diffusion spot prices with time dependent volatility, (iii) HJM-based and (iv) Lévy multifactor model with NIG distributions. Value-at-Risk measures based on normality strongly underestimate tail risk whereas our model gives estimates that are more accurate.

Keywords: Electricity swaps, Stochastic forward premium, Multivariate Normal Inverse Gaussian distribution, Lévy processes

JEL Classification: C51, G13, L94, Q40

Suggested Citation

Blanco, Iván and Peña, Juan Ignacio and Rodríguez, Rosa, Modelling Electricity Swaps with Stochastic Forward Premium Models (December 18, 2016). The Energy Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2887063 or http://dx.doi.org/10.2139/ssrn.2887063

Iván Blanco (Contact Author)

CUNEF ( email )

C/ Leonardo Prieto Castro, 2
Madrid, Madrid 28040
Spain

HOME PAGE: http://cunef.edu/

Juan Ignacio Peña

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain
34 91 624 9625 (Phone)
34 91 624 9608 (Fax)

Rosa Rodriguez

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
Spain

HOME PAGE: http://www.business.uc3m.es/en/faculty/profesor/perfil/42

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