Heavy-tails and regime-switching in electricity prices

Weron, Rafal (2008): Heavy-tails and regime-switching in electricity prices. Forthcoming in: Mathematical Methods of Operations Research

Abstract

In this paper we first analyze the stylized facts of electricity prices, in particular, the extreme volatility and price spikes which lead to heavy-tailed distributions of price changes. Then we calibrate Markov regime-switching (MRS) models with heavy-tailed components and show that they adequately address the aforementioned characteristics. Contrary to the common belief that electricity price models ‘should be built on log-prices’, we find evidence that modeling the prices themselves is more beneficial and methodologically sound, at least in case of MRS models.

• Item Type: MPRA Paper
• Language: English
• Keywords: Electricity spot price, Heavy-tails, Spikes, Markov regime-switching, Pareto distribution
• 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

References

Benth FE, Benth JS, Koekebakker S (2008) Stochastic Modeling of Electricity and Related Markets. World Scientific, Singapore

Benz E, Trueck S (2006) CO2 emission allowances trading in Europe – Specifying a new class of assets. Problems and Perspectives in Management 4(3): 30-40

Bierbrauer M, Menn C, Rachev ST, Trueck S (2007) Spot and derivative pricing in the EEX power market. Journal of Banking and Finance 31: 3462-3485

Bierbrauer M, Trueck S, Weron R (2004) Modeling electricity prices with regime switching models. Lecture Notes in Computer Science 3039: 859-867

Bottazzi G, Sapio S, Secchi A (2005) Some statistical investigations on the nature and dynamics of electricity prices. Physica A 355: 54-61

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

Burnecki K, Klafter J, Magdziarz M, Weron A (2008) From solar flare time series to fractional dynamics. Physica A 387: 1077-1087

Bystrom HNE (2005) Extreme value theory and extremely large electricity price changes. International Review of Economics and Finance 14: 41-55

Chan KF, Gray P (2006) Using extreme value theory to measure value-at-risk for daily electricity spot prices. International Journal of Forecasting 22: 283-300

Cizek P, Haerdle W, Weron R, eds. (2005) Statistical Tools for Finance and Insurance. Springer, Berlin

De Jong C (2006) The nature of power spikes: A regime-switch approach. Studies in Nonlinear Dynamics & Econometrics 10(3), Article 3

Dempster A, Laird N, Rubin DB (1977) Maximum likelihood from incomplete data via the EM algorithm. Journal of the Royal Statistical Society 39: 1-38

Deng S-J, Jiang W (2005) Levy process-driven mean-reverting electricity price model: The marginal distribution analysis. Decision Support Systems 40: 483-494

Eberlein E, Stahl G (2003) Both sides of the fence: A statistical and regulatory view of electricity risk. Energy & Power Risk Management 8(6): 34-38

Ethier R, Mount T, (1998) Estimating the volatility of spot prices in restructured electricity markets and the implications for option values. PSerc Working Paper 98-31

Hamilton J (1990) Analysis of time series subject to changes in regime. Journal of Econometrics 45: 39-70

Huisman R, de Jong C (2003) Option pricing for power prices with spikes. Energy Power Risk Management 7.11: 12-16

Huisman R, Mahieu R (2003) Regime jumps in electricity prices. Energy Economics 25: 425-434

Kaminski V (2004) Managing Energy Price Risk: The New Challenges and Solutions, 3rd ed. Risk Books, London

Khindanova I, Atakhanova Z (2002) Stable modeling in energy risk management. Mathematical Methods of Operations Research 55: 225-245

Mugele C, Rachev ST, Trueck S (2005) Stable modeling of different European power markets. Investment Management and Financial Innovations 2(3): 65-85

Nowicka-Zagrajek J, Wylomanska A (2008) Measures of dependence for stable AR(1) models with time-varying coefficients. Stochastic Models 24(1): 58-70

Paolella MS, Taschini L (2008) An econometric analysis of emission allowance prices. Journal of Banking and Finance, forthcoming, doi:10.1016/j.jbankfin.2007.09.024

Park H, Mjelde JW, Bessler DA (2006) Price dynamics among U.S. electricity spot markets. Energy Economics 28(1): 81-101

Rachev ST, Mittnik S (2000) Stable Paretian Models in Finance. Wiley

Rachev ST, Trueck S, Weron R (2004) Risk management in the power markets (part III): Advanced spot price models and VaR. RISKNEWS 05/2004: 67-71 (in German)

Simonsen I (2005) Volatility of power markets. Physica A 355: 10-20

Trueck S, Weron R, Wolff R (2007) Outlier treatment and robust approaches for modeling electricity spot prices. Proceedings of the 56th Session of the ISI, Invited Paper Meeting IPM71, Aug. 22-29, 2007, Lisbon, Portugal

Weron R (2004) Computationally intensive Value at Risk calculations. In: Gentle JE, Haerdle W, Mori Y (eds.), Handbook of Computational Statistics, Springer, Berlin, 911-950

Weron R (2006) Modeling and forecasting electricity loads and prices: A statistical approach. Wiley, Chichester

Weron R (2008) Market price of risk implied by Asian-style electricity options and futures. Energy Economics 30: 1098-1115

Weron R, Misiorek A (2007) Heavy tails and electricity prices: Do time series models with non-Gaussian noise forecast better than their Gaussian counterparts? Prace Naukowe Akademii Ekonomicznej we Wroclawiu 1076: 472-480