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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

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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.

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