A semiparametric factor model for electricity forward curve dynamics

Borak, Szymon and Weron, Rafal (2008): A semiparametric factor model for electricity forward curve dynamics. Forthcoming in: Journal of Energy Markets No. 1 (3) (2008): pp. 3-16.

Abstract

In this paper we introduce the dynamic semiparametric factor model (DSFM) for electricity forward curves. The biggest advantage of our approach is that it not only leads to smooth, seasonal forward curves extracted from exchange traded futures and forward electricity contracts, but also to a parsimonious factor representation of the curve. Using closing prices from the Nordic power market Nord Pool we provide empirical evidence that the DSFM is an efficient tool for approximating forward curve dynamics.

• Item Type: MPRA Paper
• Language: English
• Keywords: power market, forward electricity curve, dynamic semiparametric factor model
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C51 - Model Construction and Estimation; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy > Q40 - General; G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing

References

Adams, K.J., van Deventer, D. R. (1994). Fitting yield curves and forward rate curves with maximum smoothness, Journal of Fixed Income 4, 52-62.

Benth, F.E., Koekebakker, S., Ollmar, F. (2007). Extracting and applying smooth forward curves from average-based commodity contracts with seasonal variation, Journal of Derivatives, Fall, 52-66.

Borak, S., Haerdle, W., Mammen, E., Park, B. (2007). Time series modelling with semiparametric factor dynamics, Discussion Paper SfB 649, Humboldt-Universitaet zu Berlin.

Bunn, D.W., ed. (2004). Modelling Prices in Competitive Electricity Markets, Wiley, Chichester.

De Boor, C. (2001). A Practical Guide to Splines, Springer-Verlag, New York.

Fengler, M.R., Haerdle, W., Mammen, E. (2007). A semiparametric factor model for implied volatility surface dynamics, Journal of Financial Econometrics 5(2), 189-218.

Fielden, S. (2005). Shopping for curves, Energy Risk, March, 122-124.

Fleten, S.E., Lemming, J. (2003). Constructing forward price curves in electricity markets, Energy Economics 25, 409-424.

Hagan, P.S., West, G. (2006). Interpolation methods for curve construction, Applied Mathematical Finance 13(2), 89-129.

Harris, C. (2006). Electricity Markets: Pricing, Structures and Economics, Wiley, Chichester.

Haerdle, W., Mueller, M., Sperlich, S., Werwatz, A. (2004). Nonparametric and Semiparametric Models, Springer Verlag, Heidelberg.

Koekebakker, S., Ollmar, F. (2005). Forward curve dynamics in the Nordic electricity market, Managerial Finance 31(6), 73-94.

Litterman, R., Scheinkman, J. (1991). Common Factors Affecting Bond Returns, Journal of Fixed Income 1, 62-74.

Pena, D., Box, E. P. (1987). Identifying a simplifying structure in time series, Journal of the American Statistical Association 82, 836-843.

Ramsay, J.O., Silverman, B.W. (1997). Functional Data Analysis, Springer-Verlag, Berlin.

Steeley, J.M. (1990). Modeling the dynamics of the term structure of interest rates, Economic and Social Review 21(4), 337-661.

Weron, R. (2006). Modeling and Forecasting Electricity Loads and Prices: A Statistical Approach, Wiley, Chichester.