Modeling the Exact Convergence of Electricity Prices in Interconnected Markets

19 Pages Posted: 11 Jan 2019

See all articles by Troels Sønderby Christensen

Troels Sønderby Christensen

Aalborg University - Department of Mathematical Sciences; Centrica Energy Trading

Fred Espen Benth

University of Oslo

Date Written: January 9, 2019

Abstract

The liberalization of energy markets worldwide during recent decades has introduced severe implications on the price formation in these markets. Especially within the European day-ahead electricity markets, increased physical connections between different market areas and a joint effort on optimizing the aggregate social welfare have led to highly connected markets. Consequently, observing the exact same hourly day-ahead prices --- exact price convergence --- for two or more interconnected electricity markets in Europe happens frequently, which affects the modeling of such prices and in turn the valuation of derivatives written on prices from such interconnected market areas. In this paper, we propose a continuous-time model that takes this feature into account in a reduced-form manner. We discuss the properties of the model and propose an estimation procedure. Furthermore, the properties of the model reveals that analytical prices are attainable for e.g. forwards and spread options.

Keywords: Day-Ahead Electricity Prices, Interconnected Markets, Stochastic Modeling, Derivative Pricing

JEL Classification: C3, G1, Q4

Suggested Citation

Christensen, Troels Sønderby and Benth, Fred Espen, Modeling the Exact Convergence of Electricity Prices in Interconnected Markets (January 9, 2019). Available at SSRN: https://ssrn.com/abstract=3312602 or http://dx.doi.org/10.2139/ssrn.3312602

Troels Sønderby Christensen (Contact Author)

Aalborg University - Department of Mathematical Sciences ( email )

Fredrik Bajers Vej 7E
Aalborg
Denmark

Centrica Energy Trading ( email )

Skelagervej 1
Aalborg, 9000
Denmark

Fred Espen Benth

University of Oslo ( email )

Center of Mathematics for Applications
Oslo, N-0317
Norway

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