On Transition Probabilities of Regime-Switching in Electricity Prices
24 Pages Posted: 4 Dec 2004
Date Written: December 20, 2004
We analyze transition probabilities of regime-switching in electricity prices based on supply and demand by using the structural model of Kanamura and Ohashi (2004). We show that the transition probabilities depend on the demand level and thus are not constant. This result is in sharp contrast to many models of electricity prices that assume constant transition probabilities among different regimes. We also estimate the model with a historical data in the PJM market, and analyze empirically the seasonality of the transition probabilities. The results obtained here are consistent with the observed characteristics of price spikes in electricity markets where the spikes tend to occur in summer and in winter when the demand level is high. These results support the argument by Lucia and Schwartz (2002) that asserts the importance of seasonality in modeling electricity prices.
Keywords: Electricity, Price Spikes, Transition probabilities
JEL Classification: C61, D21, G13, L94, Q40
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