In particular, Meyer-Brandis and Tankov ( 2008) argue that two or three mean reverting factors are suitable to reproduce prices in the EEX.
As a matter of fact, Meyer-Brandis and Tankov ( 2008) find that the majority of European exchanges show an auto-correlating structure of the spot prices that can be well described by a models including a sum of mean reverting processes, where the mean reversion takes place with different rates. On the other hand, Equation ( 1) allows to reproduce the well-known stylized fact for which electricity prices exhibit large price shocks (spikes), which mean revert very fast towards the original price level, as well as slower mean reverting components. On the one hand, as we shall see also in this paper, this modeling choice is still simple enough to enable for explicit evaluations of electricity contracts (like futures and forward contracts). Here, Λ is a deterministic seasonality function, X is an arithmetic Brownian motion that reflects long term expectations, e.g., of political developments, and each Y j is a mean-reverting process, that converges back to the seasonal equilibrium level Λ + X. As a matter of fact, in periods of overproduction a shut down of the power plants would cost the energy producers more than paying for getting rid of energy.įor some index-set J. Furthermore, a large energy supply combined with a low demand leads electricity prices also to become negative, a feature allowed since 2008 by the European Energy Exchange. Energy prices show very high volatility with jumps, which can be explained by the fact that energy cannot be stored on a large scale, at least in an economically feasible way. Since these seasonal patterns are predictable, they can be well described through deterministic time-dependent functions, such as a combination of different sinusoidal functions ( Escribano et al. Considerations involving the law of demand and supply can explain the presence in electricity prices of seasonal patters at different scales: Prices are typically higher during the morning and evening hours of the days, and-especially in countries where heating is performed via electricity-also in winter months.
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