Precios 2

Modelling Spot Prices in the Iberian
Electricity Market
Sandro Navarro
Departamento de Economía
Facultad de Ciencias Económicas y Empresariales
2018
Table of Contents Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
1 Introduction A multifactorial
model
2 Data
Calibration
Results and model

comparison
3 A multifactorial model
4 Calibration
5 Results and model comparison
Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
model
2 Data
Calibration
Results and model

comparison
4 Calibration

3 de 47
Electricity Market
The electricity spot market Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
The electricity market works as a mandatory pool where the pur- A multifactorial
model
chase and sale of electricity for the next day (day-ahead ) is man- Calibration
aged. Results and model
comparison
That is, all the owners of the electricity production and acquisition
units are obliged to make their oers through the market operator
in accordance with the procedure established by the latter.
The daily market is structured in a single session for each hour of

the daily programming horizon.

4 de 47
Electricity Market
The electricity spot market Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Figure 1: The spot electricity market is typically a day-ahead auction market that
does not allow for continuous trading.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
model
2 Data
Calibration
Results and model

comparison
4 Calibration

6 de 47
Electricity Market
Description of data Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Figure 2: Serie de precios spot en el período Julio 2006 - Diciembre 2012. Mercado
Ibérico de la Electricidad.

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Electricity Market
Description of data Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Figure 3: Descriptive statistics of daily spot prices for the period July 2006- December
2012. Iberian Electricity Market.

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Electricity Market
Stylized Features of Electricity Prices Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Seasonality, which is a product of the inelasticity of demand, form- Calibration
Results and model

ing clear patterns caused by economic and business activities. comparison
Other factors inuencing seasonal behavior are temporary changes

in supply and demand conditions and the fact that electricity is not
a storable asset.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Figure 4: Precios observados y componente estacional a largo plazo estimad en el

periodo Julio 2006 - Diciembre 2012. Mercado Ibérico de la Electricidad.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
Stationarity and mean reversion. A multifactorial
model
The presence of jumps, because the rate of mean reversion is much Calibration
higher than during normal evolution. Results and model

comparison
High volatility, which exhibits a combination of both stochastic

and deterministic behavior.
Non-Gaussian behavior, which occurs because spikes distort the

normal distribution expected from the natural uctuations of the
data, especially around its tails

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Electricity Market
A taxonomy of electricity spot price modeling Modelling Spot
Prices in the
approaches
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Figure 5: A taxonomy of electricity spot price modeling approaches.

12 de 47
Electricity Market
Prices in the
approaches
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
Multi-agent models generally concerned medium and long term A multifactorial
time horizons, and involved matching demand estimates to the model
Calibration
supply (Borenstein, Bushnell, and Knittel 1999; Borgosz-Koczwara,
Results and model
Weron and Wyªoma«ska 2009). comparison
Fundamental models tries to capture the basic physical and eco-

nomic relationships which are present in the production and trading
of electricity (Gonzalez, Contreras, and Bunn 2012; Karakatsani and
Bunn 2008; Kristiansen 2012; Liebl 2013).
Reduced form models, whose main intention is replicate the main

characteristics of daily electricity prices (Gjolberg and Brattested
2011; Kristiansen 2007; Ronn and Wimschulte 2009).

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Electricity Market
Prices in the
approaches
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Statistical models, which forecast the current price by using a
Calibration
mathematical combination of the previous prices and/or previous Results and model
or current values of exogenous factors (Kim, Yu, and Song 2002; comparison
Koopman, Ooms, and Carnero 2007).
Computacional intelligence (CI) models, which combines ele-

ments of learning, evolution and fuzziness to create approaches that
are capable of adapting to complex dynamic systems (Poole, Mack-
worth and Goebel 1998; Madani, Correia, Rosa and Filipe 2011;
Wang and Fu 2005).

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Electricity Market
Objectives Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
The contribution of the present work in the modeling of electricity Data
prices is threefold. A multifactorial

model
1 First, a multifactor model is developed to incorporate the styl- Calibration
ized facts of the electricity prices and to model the pattern of Results and model
comparison
clusters of jumps through stochastic jump intensity.
2 Second, a methodological contribution is presented for the es-
timation of the jump component.
3 Finally, despite having a stochastic structure for the intensity,
explicit formulas are introduced for the forward prices and also,
since our model is of arithmetic type, these formulas are rela-
tively simple to evaluate.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
model
2 Data
Calibration
Results and model

comparison
4 Calibration

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Electricity Market
A multifactorial model Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
We shall consider a model for the spot price S = (St )t∈[0.T ] of the model
form Calibration
Results and model

comparison
(d)
St = e f (t) St (1)
where:
f : [0, t] → R is a seasonal and trend component.
(d)
St are the deseasonalized prices.

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Electricity Market
Prices in the
Iberian Electricity
Market
We propose an arithmetic two-factor model of the form Sandro Navarro
(d)
St = Xt + Yt Introduction
Data
where A multifactorial
model
1 The diusive component X is Calibration
Results and model

dXt = αX (µX − Xt )dt + σX dWt comparison
2 The jump component Y satises the SDE
dYt = −αY Yt − dt + dIt

where I es a non-homogeneous compund Poisson process with
jump distribution φ and stochastic intensity `. More precisely,
we will take ` to be the solution of
d`t = −ν`t − dt + dMt (2)
where M is an homogeneous Poisson process of constant in-
tensity λ > 0.
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Electricity Market
Prices in the
Iberian Electricity
Jump distribution φ Market
Sandro Navarro
Introduction
Data
Finally, we will consider four dierent possibilities for the jump dis- A multifactorial
tribution φ and evaluate which is more convenient for this or other model
models. These possibilities are: Calibration
Results and model

comparison
1 φ ∼ N(a, b 2 ) for some a ∈ R, b > 0.

2 φ is a mixture of two distributions with positive support, each
corresponding to the laws of positive and negative jumps, re-
spectively.
More precisely, we assume that φ has a density fφ of the form
fφ (x) = pfφ+ (x) + (1 − p)fφ− (−x)

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Electricity Market
Prices in the
Iberian Electricity
Sandro Navarro
Introduction
Data
for some xed p ∈ (0, 1), where φ+ and φ− are two distribu- A multifactorial
model
tions with positive support and fφ+ , fφ− denote their respective Calibration
densities. Here, p represents the probability of a given jump be- Results and model
ing positive, whereas φ+ and φ− represent the laws of positive comparison
and negative jumps, respectively.
For simplicity, we will assume that both φ+ and φ− belong to

the same family of distributions, which can be either Gamma,
Log-normal or Generalized Pareto distributions. Recall that
their respective densities are given by the formulas:

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Electricity Market
Prices in the
Iberian Electricity
Sandro Navarro
Introduction
Data
1 The Gamma distribution Γ(a, b) has density
A multifactorial
model
b a a−1 −bx Calibration
f (x) = x e 1(0,+∞) (x)
Γ(a) Results and model
comparison
for a, b > 0.
2 The Log-normal distribution LN(a, b 2 ) has density
1 (logx−a)2
f (x) = √ e− 2b 2 1(0,+∞) (x)
x 2πb 2
for a∈R and b > 0.

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Electricity Market
Prices in the
Iberian Electricity
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
3 The Generalized Pareto distribution GP(a, b, c) has density Results and model
comparison
1
x − c −1− 1a
1[c,+∞) (x)

f (x) = 1 +a
b b
for a, b, c > 0.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
model
2 Data
Calibration
Results and model

comparison
4 Calibration

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Electricity Market
Procedure Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
The procedure includes: Calibration
Results and model

1 Deseasonalization of data. comparison
2 Identifying the factors in the deseasonalized data.

3 Estimating the parameters in the diusive component.
4 Estimating the parameters in the jump component Y .

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Electricity Market
Prices in the
Iberian Electricity
Market
Step 1: Deseasonalization Sandro Navarro
Introduction
The rst step in the algorithm is to remove the seasonality in the
Data
data, obtaining an estimated trend function fˆ and the deseasonal- A multifactorial
ized data series given by model
Calibration
(d) ˆ
Ŝt := e −f (t) St . Results and model
comparison
f (t) = s(t) + L(t) (3)

where s is a weekly periodic component and L is a long-term sea-
sonal component. Here L takes the form
2πt

L(t) = α1 sin + α2 + α3 + α4 EWMA(t; 0.975),
365
where EWMA stands for exponentially weighted moving average,
which is dened inductively by the relation
EWMA(t; λ) = (1 − λ)St + λEWMA(t − 1; λ).

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Figure 6: Deseasonalized prices

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
Step 2: Identifying the factors in the deseasonal- A multifactorial
ized data model
Calibration
Results and model

The next step is to identify and separate the diusive and jump comparison
components from the deseasonalized data.
We will apply a method know as the Hard-Thresholding ltering

algorithm, but rst we need to obtain a preliminary estimate of
the reversion rates αX and αY which the algorithm will need as an
input.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Step 2.1: Estimating the reversion rates αX and Introduction
αY Data
A multifactorial
model
We will obtain these by studying the autocorrelation function (ACF) Calibration
associated to the deseasonalized process S (d) . Since X and Y are Results and model
independent Ornstein-Ühlenbeck processes, the (stationary) auto- comparison
correlation function of S (d) = X + Y is
ρ(h) = ωe −αX h + (1 − ω)e −αY h (4)
where
Var(X )
ω= .
Var(X ) + Var(Y )
We compare the empirical autocorrelation (ACF) with the theoreti-
cal autocorrelation function for dierent factors using the L2 norm.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Table 1: The tted ACF with a sum of two exponentials. Iberian Electricity Market Calibration
between July 2006 and December 2012. Results and model
comparison
Figure 7: Empirical ACF (black) vs Theoretical ACF (red)

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Step 2.2: The Hard-Tresholding algorithm Data
A multifactorial
model
With α̂Y and α̂Y we proceed to separate the diusive and jump Calibration
components in the deseasonalized spot prices. The idea is to de- Results and model
(d)
compose the deseasonalized data as Ŝt = X̂t + g (t) where the comparison
function g represents our estimation of the jump process Y and X̂

that of X .
(d)
This algorithm proposes to determine the parameters in Ŝt above
through an iterative scheme of K steps, which can be summarized
as follows:
We take as our initial data series X (0) := Ŝ d .

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
Having constructed the series X (i) for 0 ≤ i < K , we dene A multifactorial

model
inductively the series
Calibration
(i+1) (i) Results and model

Xt := Xt − g̃ (t, αi+1 , τ̃i+1 ), comparison
where g̃ (t, τ, α) := αe −αˆY (t−τ ) 1[τ,T ] (t) and the pair (αi+1 , τ̃i+1 )
solves the least squares problem
2
( T )
X (i)
min Xt − g̃ (t, α, τ ) : α ∈ R, τ ∈ {1, . . . , T } .
t=1

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
The algorithm concludes dening the series Data
A multifactorial
K model
X
X̂ := X (K ) and g (·) = g̃ (·, αi , τ̃i ), Calibration
Results and model

i=1 comparison
(K )
where K is chosen so that in the return series (Rt )t=1,...,T
of X (K ) dened as
(K ) (K ) (K )
Rt := Xt − e −α̂X Xt−1
there are no evidences at level 0,05 to reject its Gaussianity

when performing a Jarque-Bera test.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Figure 8: Detected log jumps and log diusive component. Iberian Electricity
Market between July 2006 and December 2012.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Step 3: Estimating the parameters in the diusive Introduction
component Data
A multifactorial
model
We t the equations Calibration
Results and model

comparison
X̂t+1 = β0 + β1 X̂t + σεt
for t = 0, . . . , T − 1 by the maximum likehood method and then

obtain the estimators
log β̂12
s
βˆ0
α̂X := − log β̂1 µ̂X := σ̂X := σ̂ .
1 − β̂1 β̂12 − 1
We obtained the values α̂X = 0.0858, µ̂X = 1.0149 and σ̂X =

0.0664.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Step 4: Estimating the parameters in the jump

Data
component Y
A multifactorial
model
Calibration
Results and model

We shall base our estimation procedure in this case on a simulated comparison
moment method originally proposed in Carrasco et al. (2002).
As information one has that Y satises the system of n equations
E(hi (Yt ; θ0 )) = 0 (5)
for certain known functions h1 , . . . , hn called moment conditions.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
The eciency of the method will depend on the amount n of equa- Data
tions at our disposal, although it will always remain below the one A multifactorial
achieved via the maximum likelihood (ML) method. model
Calibration
Results and model

Carrasco and Florens proposed a method that achieves an asymp- comparison
totic eciency matching using a continuum of equations based on

the characteristic function of the process
hτ (Yt ; θ) := e iτ Yt − Eθ (e iτ Yt ),
so that E(hτ (Yt ; θ)) is exactly the dierence between the true char-
acteristic function and the theoretical one implied by the model with
parameter vector θ.

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Electricity Market
Prices in the
Iberian Electricity
Market
The estimation method can be summarized as follows: Sandro Navarro
1 Observe that Y satises the equation Introduction
Data
E(hi (Yt ; θ0 )) = 0 A multifactorial

model
Calibration
for all τ ∈ R, where θ0 are the true parameters and
Results and model
comparison
iτ Yt iτ Yt
ht (τ, Y ; θ) = e − Eθ (e ).
2 We approximate E(ht (τ, Y ; θ0 )) by its sample version
T J
1 X iτ Yt 1 X iτ Ytθ
ht (τ, Y ; θ) = e − e
T t=1 J t=1
where (Y θ )t=1,..,J is a simulated series with parameters θ.

3 We take our estimator θ̂0 := arg minθ∈Θ ||ht (•, Y ; θ)||, where
|| • || is a suitable norm in the space of functions (in τ ).

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
We use an algorithm developed by Grynkiv (2012) which selects a model
nite number of moment conditions from the continuum of available Calibration
ones in such a way that the estimator obtained using only this nite Results and model
comparison
set of conditions is essentially ecient.
Since we do not know a priori the distribution of jumps in our model,

we calibrate our model using four dierent possible jump distribu-
tions and then select the one which is most appropriate following
the outcome of the goodness-of-t test.

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Table 2: Estimating parameters of jump component

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Electricity Market
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
model
2 Data
Calibration
Results and model

comparison
4 Calibration

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Electricity Market
Testing model Modelling Spot
Prices in the
Iberian Electricity
Benchmark models Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Cartea-Figueroa (CF): Calibration
Results and model

dXt = −αX Xt dt + σX dBt + dJt (6) comparison
Hambly-Howison-Kluge (HHK):
(d)
St = exp(Xt + Yt ), where
dXt = −αX Xt dt + σX dBt (7)
dYt = −αY Yt dt + dJt (8)

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Electricity Market
Testing model Modelling Spot
Prices in the
Iberian Electricity
Benchmark models Market
Sandro Navarro
Mayer-Schmid-Weber (MSW): Introduction
Diusive component is similar to HHK model, but σX (t) is a Data
GARCH (1,1) process: A multifactorial

model
Calibration
σX2 (t) = α0 + α1 ε2t + β1 σX2 (t − 1) (9) Results and model
comparison
Meyer-Brandis and Tankov (MT):

(d)
St = Xt + Yt
is proposed, where X and Y are respectively given by the SDEs


 dXt = αX (µX − Xt )dt + σX dWt
(10)
dYt = −αY Yt − dt + dIt .


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Electricity Market
Analysis of path properties Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Figure 9: Simulated spot prices under dierent model specications.

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Electricity Market
Quantile analysis Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Table 3: Goodness-of-t statistics for M and benchmark models tted to the

deseasonalized prices in the Iberian Electricity Market between July 2006 and
December 2012

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Electricity Market
Moment analysis Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Introduction
Data
A multifactorial
model
Calibration
Results and model

comparison
Table 4: Moment comparison

45 de 47
Electricity Market
Conclusions Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
About the analysis of path properties, we observe that all models Introduction
Data
perform reasonably well, being MT and M those with the trajectories
A multifactorial
which most resemble that of the original series. model
Calibration
About the quantile analysis, we see that for our model the quantile Results and model
comparison
adjustment is worse for the lower quantiles, but this also occurs for
the benchmark model.This suggests that the lowest levels of the
spot price might correspond not only to negative jumps, but also
to periods of strong volatility, a feature that cannot be captured by
constant-volatility models.
In the moment analysis, compared to the other models, we see that

our model M achieves the best results in this regard, followed closely
by MT.

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Electricity Market
References Modelling Spot
Prices in the
Iberian Electricity
Market
Sandro Navarro
Cartea, A., Figueroa, M., 2005. Pricing in electricity markets: Introduction
a mean reverting jump diusion model with seasonality. Applied Data
Mathematical Finance, 12(4),313335. A multifactorial

model
Calibration
Hambly, B., Howison, S., Kluge, T., 2009. Modelling spikes and Results and model
pricing swing options in electricity markets. Quantitative Finance, comparison
9(8), 937949.
Mayer, K., Schmid, T., Weber, F., 2015. Modeling electricity spot
prices: combining mean reversion, spikes, and stochastic volatility.
The European Journal of Finance, 21(4), 292315.
Meyer-Brandis, T., Tankov, P., 2008. Multi-factor jump-diusion

models of electricity prices. International Journal of Theoretical and
Applied Finance, 11(05), 503528.

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Electricity Market

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Modelling Spot Prices in the Iberian

Results and model

5 Results and model comparison

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

5 Results and model comparison

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

The daily market is structured in a single session for each hour of

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

5 Results and model comparison

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Seasonality, which is a product of the inelasticity of demand, form- Calibration

Results and model

Other factors inuencing seasonal behavior are temporary changes

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

Figure 4: Precios observados y componente estacional a largo plazo estimad en el

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

higher than during normal evolution. Results and model

High volatility, which exhibits a combination of both stochastic

Non-Gaussian behavior, which occurs because spikes distort the

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

Figure 5: A taxonomy of electricity spot price modeling approaches.

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

time horizons, and involved matching demand estimates to the model

Fundamental models tries to capture the basic physical and eco-

Reduced form models, whose main intention is replicate the main

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Koopman, Ooms, and Carnero 2007).

Computacional intelligence (CI) models, which combines ele-

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

The contribution of the present work in the modeling of electricity Data

prices is threefold. A multifactorial

1 First, a multifactor model is developed to incorporate the styl- Calibration

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

5 Results and model comparison

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

Results and model

2 The jump component Y satises the SDE

dYt = −αY Yt − dt + dIt

models. These possibilities are: Calibration

Results and model

1 φ ∼ N(a, b 2 ) for some a ∈ R, b > 0.

More precisely, we assume that φ has a density fφ of the form

fφ (x) = pfφ+ (x) + (1 − p)fφ− (−x)

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

ing positive, whereas φ+ and φ− represent the laws of positive comparison

and negative jumps, respectively.

For simplicity, we will assume that both φ+ and φ− belong to

Sandro Navarro (UDEP) Modelling Spot Prices in the Iberian

2 The Log-normal distribution LN(a, b 2 ) has density

Other factors inuencing seasonal behavior are temporary changes

2 The jump component Y satises the SDE

We will apply a method know as the Hard-Thresholding ltering

Having constructed the series X (i) for 0 ≤ i < K , we dene A multifactorial

The algorithm concludes dening the series Data

Step 3: Estimating the parameters in the diusive Introduction

As information one has that Y satises the system of n equations

totic eciency matching using a continuum of equations based on

1 Observe that Y satises the equation Introduction

nite number of moment conditions from the continuum of available Calibration