Applying mathematical finance tools to the competitive Nordic electricity market
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Doctoral thesis (article-based)
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Author
Date
2004-12-03
Major/Subject
Mcode
Degree programme
Language
en
Pages
34, [63]
Series
Research reports / Helsinki University of Technology, Institute of Matematics. A, 475
Abstract
This thesis models competitive electricity markets using the methods of mathematical finance. Fundamental problems of finance are market price modelling, derivative pricing, and optimal portfolio selection. The same questions arise in competitive electricity markets. The thesis presents an electricity spot price model based on the fundamental stochastic factors that affect electricity prices. The resulting price model has sound economic foundations, is able to explain spot market price movements, and offers a computationally efficient way of simulating spot prices. The thesis shows that the connection between spot prices and electricity forward prices is nontrivial because electricity is a commodity that must be consumed immediately. Consequently, forward prices of different times are based on the supply-demand conditions at those times. This thesis introduces a statistical model that captures the main characteristics of observed forward price movements. The thesis presents the pricing problems relating to the common Nordic electricity derivatives, as well as the pricing relations between electricity derivatives. The special characteristics of electricity make spot electricity market incomplete. The thesis assumes the existence of a risk-neutral martingale measure so that formal pricing results can be obtained. Some concepts introduced in financial markets are directly usable in the electricity markets. The risk management application in this thesis uses a static optimal portfolio selection framework where Monte Carlo simulation provides quantitative results. The application of mathematical finance requires careful consideration of the special characteristics of the electricity markets. Economic theory and reasoning have to be taken into account when constructing financial models in competitive electricity markets.Description
Keywords
mathematical finance, electricity markets, risk management, derivative pricing, stochastic modelling
Other note
Parts
- Vehviläinen I. and Pyykkönen T., Stochastic factor model for electricity spot price – the case of the Nordic market. Energy Economics, to appear. [article1.pdf] © 2004 by authors and © 2004 Elsevier Science. By permission.
- Audet N., Heiskanen P., Keppo J., and Vehviläinen I., 2004. Modeling electricity forward curve dynamics in the Nordic market. In: Bunn D. W. (editor), Modelling Prices in Competitive Electricity Markets. Wiley, pages 251-265. [article2.pdf] © 2004 John Wiley & Sons, Inc. By permission.
- Vehviläinen I., 2002. Basics of electricity derivative pricing in competitive markets. Applied Mathematical Finance 9, number 1, pages 45-60. [article3.pdf] © 2002 Taylor & Francis. By permission.
- Vehviläinen I. and Keppo J., 2003. Managing electricity market price risk. European Journal of Operational Research 145, number 1, pages 136-147. [article4.pdf] © 2003 Elsevier Science. By permission.
