A ‘simple’ hybrid model for power derivatives
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AbstractThis paper presents a method for valuing power derivatives using a supply–demand approach. Our method extends work in the field by incorporating randomness into the base load portion of the supply stack function and equating it with a noisy demand process. We obtain closed form solutions for European option prices written on average spot prices considering two different supply models: a mean-reverting model and a Markov chain model. The results are extensions of the classic Black–Scholes equation. The model provides a relatively simple approach to describe the complicated price behaviour observed in electricity spot markets and also allows for computationally efficient derivatives pricing.
Article deposited according to the policy found on the Elsevier website, , http://www.elsevier.com/wps/find/authorsview.authors/postingpolicy, June 28, 2012.