Fat Tails in Power Prices

17 Pages Posted: 15 Oct 2003

See all articles by Ronald Huisman

Ronald Huisman

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

C. Huurman

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM)

Date Written: 24 2003 9,

Abstract

Spot power prices exhibit extreme price jumps and the tendency to oscillate around a long-term mean. Despite these well-known characteristics, electricity price models used for Monte Carlo simulations, VaR related measures, or derivatives valuation, often assume normally distributed residuals. In this paper, we examine the distributional characteristics of model residuals and show that the hypothesis of normality is rejected due to significant tail fatness and skewness. We then examine the Student-t distribution as a candidate fit for residuals and as an alternative distribution for random innovations in Monte Carlo simulations. The resulting price patterns clearly show that simulations based on the Student-t distribution resemble more closely actual power price patters. We then discuss the implications of our results for risk management.

Keywords: electricity price, modelling, spikes, extreme value theory, Monte Carlo simulations, risk management

JEL Classification: M, G3, G13, C15

Suggested Citation

Huisman, Ronald and Huurman, Christian, Fat Tails in Power Prices (24 2003 9,). Available at SSRN: https://ssrn.com/abstract=450992

Ronald Huisman

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

Christian Huurman (Contact Author)

Erasmus University Rotterdam (EUR) - Rotterdam School of Management (RSM) ( email )

P.O. Box 1738
Room T08-21
3000 DR Rotterdam, 3000 DR
Netherlands

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