Abstract
This paper explores a way to apply Item Response Theory (IRT), one of the popular statistical methodologies in measurement and psychometrics, to evaluate Financial Transmission Rights (FTR) paths in the U.S. electricity market. FTR is an energy derivative product to hedge congestion cost risks inherent in constrained transmission lines. In New England, with about 1200 pricing locations, the theoretical combinations of FTR paths amount to 1.4 million in prevailing flows alone. With capital constraints, it is imperative that FTR market participants build the capability to evaluate FTR paths to bid on. IRT provides a framework of how well tests work, and how individual items work on tests, estimating respondents’ latent abilities, and individual item parameters. IRT is utilized to analyze historical electricity data of 2019 for a daily congestion cost of eight customer load zones and one hub in the U.S., New England, for the evaluation of FTR paths. In the analysis, an item represents an FTR path, while item difficulty, item discrimination, and a latent trait variable for the path correspond to the path profitability, risk level, and daily congestion ability, respectively. This paper explores the experimental procedures by which IRT, a psychometric tool, may also be applicable in complex energy markets, providing a consistent and standardized analytical framework to address the issues of selection and prioritization among multiple opportunities. FTR path evaluation is conducted in three steps to determine bid priority paths in FTR auctions: parameter significance tests, ranking on path profitability and risk level, and weighting scores of individual rankings on the two criteria.
Highlights
Financial Transmission Rights (FTR) is an energy derivative that allows market participants to receive an annual or monthly share of congestion cost revenues collected in settled electricity prices, or locational marginal price (LMP), by Independent System Operators (ISO) [1,2]
Item Response Theory (IRT) may be applied to FTR markets, where the astonishing number of paths are available, 1.4 million paths in U.S New England ISO alone, and a consistent and standardized evaluation model is required for FTR participants to understand return and risk profiles of path they are interested in
This paper is the first experiment to apply IRT, the IRT 2PL model, to the U.S energy market, in evaluating and selecting the FTR paths to bid in market auctions
Summary
Financial Transmission Rights (FTR) is an energy derivative that allows market participants to receive an annual or monthly share of congestion cost revenues collected in settled electricity prices, or locational marginal price (LMP), by Independent System Operators (ISO) [1,2]. IRT is popular in the psychometrics discipline, there have been several studies on the paper will use the term latent trait and ability interchangeably in describing the IRT and its applications of the theory in the fields of health behavior research [6,7], as well as in financial literacy application to FTR path evaluation in the U.S electricity market. Factors estimation and2PL comparison of their return and risk profiles With such capability, In involve summary, the IRT model provides analytical advantages in terms of parameter may be applied to FTR markets,interpretation, where the astonishing number of paths aremultiple available,items, 1.4 million paths parsimony, easier parameter distinguishability among and visual in.
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