Abstract
The presence of optionality in the generation and transmission of power means that valuing physical and financial assets requires using option theory, which in turn requires studying stochastic processes appropriate for the description of power prices. Power prices are much more volatile than other commodity prices and exhibit interesting behavior such as regime switching between normal and spiked states. The probability distributions underlying such stochastic process provide an input for price forecasts, which are based on price history. They also provide an input into valuation of transmission and transmission options in cases where the implied market-based measures of volatilities and correlations are lacking. Combining information from this analysis of stochastic processes for power prices with the Black–Scholes framework for option valuation, specifically using that framework to calculate the value of spread options, yields methods for calculating the value of transmission as well as for calculating the value of financial transmission options, which also depend on spread of power prices. The three main techniques for obtaining the option value include analytical approaches, binomial-type trees (finite difference methods), and Monte Carlo simulations. Each of these techniques presented in the paper has its own advantages and disadvantages and is complementary to the other two, providing independent validation and quality control for transmission valuation algorithms.
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Rosenberg, M., Bryngelson, J.D., Baron, M., Papalexopoulos, A.D. (2010). Transmission Valuation Analysis based on Real Options with Price Spikes. In: Rebennack, S., Pardalos, P., Pereira, M., Iliadis, N. (eds) Handbook of Power Systems II. Energy Systems. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-12686-4_4
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DOI: https://doi.org/10.1007/978-3-642-12686-4_4
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