Pricing swing options in the electricity markets under regime-switching uncertainty

M. I. M. Wahab, Z. Yin and N. C. P. Edirisinghe

Quantitative Finance, 2010, vol. 10, issue 9, 975-994

Abstract: The spot price market for electricity is highly volatile. The time series of the daily average electricity price is characterised by seasonality, mean reversion, jumps, and regime-switching processes. In electricity markets, 'swing' contracts, which can provide some protection against the day-to-day price fluctuations, are used to incorporate flexibility in acquiring given quantities of electricity. We develop a lattice approach for the valuation of swing options by modelling the daily average price of electricity by a regime-switching process that utilises three regimes, consisting of Brownian motions and a mean-reverting process. Various numerical examples are presented to illustrate the methodology.

Keywords: Swing option; Regime-switching process; Mean-reverting process; Electricity market (search for similar items in EconPapers)
Date: 2010
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DOI: 10.1080/14697680903547899

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