Valuation of power plants by utility indifference and numerical computation

Arnaud Porchet (), Nizar Touzi () and Xavier Warin ()

Mathematical Methods of Operations Research, 2009, vol. 70, issue 1, 47-75

Abstract: This paper presents a real option valuation model of a power plant, which accounts for physical constraints and market incompleteness. Switching costs, minimum on-off times, ramp rates, or non-constant heat rates are important characteristics that can lead, if neglected, to overestimated values. The existence of non-hedgeable uncertainties is also a feature of energy markets that can impact assets value. We use the utility indifference approach to define the value of the physical asset. We derive the associated mixed optimal switching-control problem and provide a characterization of its solution by means of a coupled system of reflected Backward Stochastic Differential Equations (BSDE). We relate this system to a system of variational inequalities, and we provide a numerical comparative study by implementing BSDE simulation algorithms, and PDE finite differences schemes. Copyright Springer-Verlag 2009

Keywords: Real option; Backward stochastic differential equation; Utility indifference; Non-linear Monte Carlo methods; Finite differences for PDE (search for similar items in EconPapers)
Date: 2009
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Citations: View citations in EconPapers (10)

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DOI: 10.1007/s00186-008-0231-z

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