Modelling electricity futures prices using seasonal path-dependent volatility
2016
Fanelli, Viviana | Maddalena, Lucia | Musti, Silvana
The liberalization of electricity markets gave rise to new patterns of futures prices and the need of models that could efficiently describe price dynamics grew exponentially, in order to improve decision making for all of the agents involved in energy issues. Although there are papers focused on modelling electricity as a flow commodity by using Heath et al. (1992) approach in order to price futures contracts, the literature is scarce on attempts to consider a seasonal volatility as input to models. In this paper, we propose a futures price model that allows looking into observed stylized facts in the electricity market, in particular stochastic price variability, and periodic behavior. We consider a seasonal path-dependent volatility for futures returns that are modelled in Heath et al. (1992) framework and we obtain the dynamics of futures prices. We use these series to price the underlying asset of a call option in a risk management perspective. We test the model on the German electricity market, and we find that it is accurate in futures and option value estimates. In addition, the obtained results and the proposed methodology can be useful as a starting point for risk management or portfolio optimization under uncertainty in the current context of energy markets.
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