Exotic options bundled with interruptible electricity contracts

Abstract

An interruptible electricity contract (IEC) is a type of electricity contract bundled with electricity options which can be used in demand side management. A portfolio consisting of an electricity option integrated with an interruptible electricity contract is the same as an exotic option composed of several call barrier options. The complexity of this exotic electricity option makes it difficult (and probably impossible) to determine its price in terms of an analytic expression. A Monte Carlo valuation is used to value the option in this paper, and a formula for the value of the exotic option is proposed under no-arbitrage conditions. Historical price and load rate data are analyzed to develop a hybrid model comprising a mean regression model and a jump model for market clearing prices. New England power market data are employed in numerical examples to value the exotic option. The numerical results show that the relative error between the actual value and the value calculated by the Monte Carlo valuation is less than 5%, and that the value of the exotic option varies with the expectation of the jump model