The Market Price of Risk for Delivery Periods: Pricing Swaps and Options in Electricity Markets

Annika Kemper, Maren Diane Schmeck and Anna Khripunova Balci
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Annika Kemper: Center for Mathematical Economics, Bielefeld University
Maren Diane Schmeck: Center for Mathematical Economics, Bielefeld University
Anna Khripunova Balci: Center for Mathematical Economics, Bielefeld University

No 635, Center for Mathematical Economics Working Papers from Center for Mathematical Economics, Bielefeld University

Abstract: In electricity markets, futures contracts typically function as a swap since they deliver the underlying over a period of time. In this paper, we introduce a market price for the delivery periods of electricity swaps, thereby opening an arbitrage-free pricing framework for derivatives based on these contracts. Furthermore, we use a weighted geometric averaging of an artificial geometric futures price over the corresponding delivery period. Without any need for approximations, this averaging results in geometric swap price dynamics. Our framework allows for including typical features as the Samuelson effect, seasonalities, and stochastic volatility. In particular, we investigate the pricing procedures for electricity swaps and options in line with Arismendi et al. (2016), Schneider and Tavin (2018), and Fanelli and Schmeck (2019). A numerical study highlights the differences between these models depending on the delivery period.

Keywords: Electricity Swaps; Delivery Period; Market Price of Delivery Risk; Seasonality; Samuelson Effect; Stochastic Volatility; Option Pricing; Heston Model (search for similar items in EconPapers)
Date: 2020-05-11
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https://pub.uni-bielefeld.de/download/2943342/2943343 First Version, 2020 (application/pdf)

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