Introduction and Survey

Abstract

In part IV we develop a continuous-time pricing model for one of the latest cash markets to be transformed by derivative securities — the electricity market. Based on available data on electricity derivatives we focus our attention on the valuation of short-term electricity forwards. First, we investigate the more mature futures markets contracted on established commodity underlyings and describe proposed pricing models for traditional commodity futures contracts from the literature. Thereby, we gather relevant information about the commodity electricity in order to build an appropriate valuation model to price electricity forwards in chapter 15. From given model assumptions we derive a closed-form valuation model for electricity forwards using the risk-neutral pricing technique of the EMM-approach. The suggested model especially captures the high and time varying volatility seen in electricity prices. In chapter 16 we present an empirical adaptation of the theoretical pricing model in state space form. Using maximum likelihood estimation based on extended Kalman filtering we report empirical results on electricity data from the largely deregulated Californian electricity market. In the last chapter we conclude.