Common Unobserved Determinants of Intraday Electricity Prices

Abstract

Electricity prices are known to have special statistical properties, where long-memory effects, varying-level periodicities, cross-dependencies and other exogenous influences often work together to form a complex data-generating process. The need for accurately representing all these features typically leads us to complex parametrizations, which are prone to numerical instabilities, overfitting and poor transparency. A natural counterpart to an overparameterized model is accomplished by the use of factor decomposition techniques to simplify the modeling process by implementing a more compact factor structure for the cross-section of electricity prices. In this paper, we exploit multi-level factor modelling techniques to unravel systematic unobserved determinants of the intraday and interzonal price curve dynamics. These techniques make an explicit separation of global drivers from region-specific common factors, thereby facilitating the identification of the actual sources of co-variability. Our findings on the Pennsylvania-New Jersey-Maryland (PJM) interconnection confirm the hypothesis that the common unobserved determinants of power prices in this interconnection obey a block structure, some of which affect different segments of our panel. We argue that a multi-level factor approach offers a more systematic and transparent representation of intertemporal and cross-sectional patterns in PJM electricity prices compared to alternative brute-force VARMAX parametrizations and the ``flat" factor models, which are often put forward in the literature as viable modelling alternatives.

Keywords: Multi-level factor models, power price dynamics, day-ahead electricity markets, PJM interconnection