An interconnector is an asset that gives the owner the right, but not the obligation, to transmit electricity between two locations each hour of the day over a prefixed time period. The financial value of the interconnector is given by a series of options that are written on the price differential between two electricity markets, that is, a strip of European options on an hourly spread. Since the hourly forward price is not directly observable on the market, Chapter 1 proposes a practical procedure to build an hourly forward price curve, fitting both base load and peak load forward quotations. One needs a stochastic model, a valuation formula, and a calibration method to evaluate interconnection capacity contracts. To capture the main features of the electricity price series, we model the energy price log-returns for each hour with a non-Gaussian mean-reverting stochastic process. Unfortunately no explicit solution to the spread option valuation problem is available. Chapter 2 develops a method for pricing the generic spread option in the non-Gaussian framework by extending the Bjerksund and Stensland (2011) approximation to a Fourier transform framework. We also obtain an upper bound on the estimation error. The method is applicable to models in which the joint characteristic function of the underlying assets is known analytically. Since an option on the difference of two prices is a particular case of a basket option, Chapter 3 extends our results to basket option pricing, obtaining a lower and an upper bound on the estimated price. We propose a general lower approximation to the basket option price and provide an upper bound on the estimation error. The method is applicable to models in which the joint characteristic function of the underlying assets and the geometric average is known. We test the performance of these new pricing algorithms, considering different stochastic dynamic models. Finally, in Chapter 4, we use the proposed spread option pricing method to price interconnectors. We show how to set up a calibration procedure: A market-coherent calibration is obtained, reproducing the hourly forward price curve. Finally, we present several examples of interconnector capacity contract valuation between European countries.

(2012). Spread and basket option pricing: an application to interconnected power markets. (Tesi di dottorato, Università degli Studi di Milano-Bicocca, 2012).

Spread and basket option pricing: an application to interconnected power markets

CALDANA, RUGGERO
2012

Abstract

An interconnector is an asset that gives the owner the right, but not the obligation, to transmit electricity between two locations each hour of the day over a prefixed time period. The financial value of the interconnector is given by a series of options that are written on the price differential between two electricity markets, that is, a strip of European options on an hourly spread. Since the hourly forward price is not directly observable on the market, Chapter 1 proposes a practical procedure to build an hourly forward price curve, fitting both base load and peak load forward quotations. One needs a stochastic model, a valuation formula, and a calibration method to evaluate interconnection capacity contracts. To capture the main features of the electricity price series, we model the energy price log-returns for each hour with a non-Gaussian mean-reverting stochastic process. Unfortunately no explicit solution to the spread option valuation problem is available. Chapter 2 develops a method for pricing the generic spread option in the non-Gaussian framework by extending the Bjerksund and Stensland (2011) approximation to a Fourier transform framework. We also obtain an upper bound on the estimation error. The method is applicable to models in which the joint characteristic function of the underlying assets is known analytically. Since an option on the difference of two prices is a particular case of a basket option, Chapter 3 extends our results to basket option pricing, obtaining a lower and an upper bound on the estimated price. We propose a general lower approximation to the basket option price and provide an upper bound on the estimation error. The method is applicable to models in which the joint characteristic function of the underlying assets and the geometric average is known. We test the performance of these new pricing algorithms, considering different stochastic dynamic models. Finally, in Chapter 4, we use the proposed spread option pricing method to price interconnectors. We show how to set up a calibration procedure: A market-coherent calibration is obtained, reproducing the hourly forward price curve. Finally, we present several examples of interconnector capacity contract valuation between European countries.
FUSAI, GIANLUCA
Hourly forward price curve, spread option, basket option, stochastic process, characteristic function, numerical methods, interconnection capacity contract, electricity market, spot price model calibration.
SECS-S/06 - METODI MATEMATICI DELL'ECONOMIA E DELLE SCIENZE ATTUARIALI E FINANZIARIE
English
12-nov-2012
MATEMATICA PER L'ANALISI DEI MERCATI FINANZIARI - 31R
25
2011/2012
open
(2012). Spread and basket option pricing: an application to interconnected power markets. (Tesi di dottorato, Università degli Studi di Milano-Bicocca, 2012).
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/10281/39422
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