Pricing electricity risk by interest rate methods

Juri Hinz, Lutz Von Grafenstein, Michel Verschuere and Martina Wilhelm

Quantitative Finance, 2005, vol. 5, issue 1, 49-60

Abstract: We address a method for pricing electricity contracts based on the valuation of the ability to produce power, which is considered as the true underlying factor for electricity derivatives. This approach shows that an evaluation of free production capacity provides a framework where a change-of-numeraire transformation converts the electricity forward market into the common settings for money market modelling. Using the toolkit of interest rate theory, we derive explicit option pricing formulas.

Date: 2005
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DOI: 10.1080/14697680500040876

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