From bid-stacks to swing options in electricity markets

Thu, 09/06/2011 13:00	Ben Hambly	Mathematical Finance Internal Seminar	DH 1st floor SR
	From bid-stacks to swing options in electricity markets
	The aim of this work is to show how to derive the electricity price from models for the underlying construction of the bid-stack. We start with modelling the behaviour of power generators and in particular the bids that they submit for power supply. By modelling the distribution of the bids and the evolution of the underlying price drivers, that is the fuels used for the generation of power, we can construct an spede which models the evolution of the bids. By solving this SPDE and integrating it up we can construct a bid-stack model which evolves in time. If we then specify an exogenous demand process it is possible to recover a model for the electricity price itself. In the case where there is just one fuel type being used there is an explicit formula for the price. If the SDEs for the underlying bid prices are Ornstein-Uhlenbeck processes, then the electricity price will be similar to this in that it will have a mean reverting character. With this price we investigate the prices of spark spreads and swing options. In the case of multiple fuel drivers we obtain a more complex expression for the price as the inversion of the bid stack cannot be used to give an explicit formula. We derive a general form for an SDE for the electricity price. We also show that other variations lead to similar, though still not tractable expressions for the price.