A Regime-Switching Copula Approach to Modeling Day-Ahead Prices in Coupled Electricity Markets (Pre-print)

Working paper

24 Pages Posted: 7 Feb 2017 Last revised: 23 Oct 2017

Date Written: September 15, 2017

Abstract

The recent price coupling of many European electricity markets has triggered a fundamental change in the interaction of day-ahead prices, challenging additionally the modeling of the joint behavior of prices in interconnected markets. In this paper we propose a regime-switching AR-GARCH copula to model pairs of day-ahead electricity prices in coupled European markets. While capturing key stylized facts empirically substantiated in the literature, this model easily allows us to 1) deviate from the assumption of normal margins and 2) include a more detailed description of the dependence between prices. We base our empirical study on four pairs of prices, namely Germany-France, Germany-Netherlands, Netherlands-Belgium and Germany-Western Denmark. We find that the marginal dynamics are better described by the flexible skew t distribution than the benchmark normal distribution. Also, we find significant evidence of tail dependence in all pairs of interconnected areas we consider. As applications of the proposed empirical model, we consider the pricing of financial transmission rights and the forecasting of tail quantiles. In both applications, we highlight the effects of the distributional assumptions for the margins and the tail dependence.

Keywords: Day-Ahead Electricity Prices, Market Coupling, Copula Models, Tail Dependence, Financial Transmission Rights, Tail Quantile Forecasting

JEL Classification: C32, C51, G13

Suggested Citation

Pircalabu, Anca and Benth, Fred Espen, A Regime-Switching Copula Approach to Modeling Day-Ahead Prices in Coupled Electricity Markets (Pre-print) (September 15, 2017). Working paper, Available at SSRN: https://ssrn.com/abstract=2912312 or http://dx.doi.org/10.2139/ssrn.2912312

Anca Pircalabu (Contact Author)

Aalborg University ( email )

Fredrik Bajers Vej 7E
Aalborg, DK-9220
Denmark

Fred Espen Benth

University of Oslo ( email )

Center of Mathematics for Applications
Oslo, N-0317
Norway

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