Applied Models of Heavy Tails and Skewness in Energy Prices with an Application to Electricity Price Risk

W. Walls and Wei Zhang

Chapter 8 in Handbook of Energy Finance:Theories, Practices and Simulations, 2020, pp 185-213 from World Scientific Publishing Co. Pte. Ltd.

Abstract: Energy prices are characterized by distributions that are asymmetric and that have heavier than Gaussian tails. Yet, many researchers continue to employ statistical methods that do not explicitly account for heavy tails and skewness in energy prices. In this chapter, we explicitly account for heavy tails and skewness with an application to electricity price risk using the Generalized Pareto Distribution and the Generalized Extreme Value Distribution. Specifically, we model value-at-risk (VaR) which is a widely-used measure of the maximum potential change in value of a portfolio of financial assets with a given probability over a given time horizon. VaR has become a standard measure of market risk and a common practice is to compute VaR by assuming that changes in value of the portfolio are conditionally normally distributed. However, assets returns usually come from heavy-tailed distributions, so computing VaR under the assumption of conditional normality can be an important source of error. We illustrate in our application to electric power, that VaR estimates based on extreme value theory models — in particular the generalized Pareto distribution — are more accurate than those produced by alternative models such as normality or historical simulation.

Keywords: Energy Finance; Financial and Economic Modeling; Volatility; Forecasting; Quantitative Finance; Energy Markets (search for similar items in EconPapers)
JEL-codes: G20 G32 Q40 (search for similar items in EconPapers)
Date: 2020
References: Add references at CitEc
Citations:

Downloads: (external link)
https://www.worldscientific.com/doi/pdf/10.1142/9789813278387_0008 (application/pdf)
https://www.worldscientific.com/doi/abs/10.1142/9789813278387_0008 (text/html)
Ebook Access is available upon purchase.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:wsi:wschap:9789813278387_0008

Ordering information: This item can be ordered from

Access Statistics for this chapter

More chapters in World Scientific Book Chapters from World Scientific Publishing Co. Pte. Ltd.
Bibliographic data for series maintained by Tai Tone Lim ().