Model risk regarding monthly wind energy production for the valuation of a wind farm investment

Abstract

PurposeThe purpose of this paper is to assess model risk with regard to wind energy output in monthly cash flow models for the purpose of valuation and risk assessment of wind farm investments, where only a few approaches exist in the literature.Design/methodology/approachThis paper focuses on the risk-return characteristics of this investment from the perspective of private and institutional investors and takes into account several risks, in particular the resource risk related to the uncertainty of the monthly wind energy produced. To this end, this paper presents different approaches for modeling monthly wind power output and assesses the impact of three selected models with different properties on the investment’s risk-return characteristics by means of a stochastic discounted cash flow model. In addition, the model considers the possibility of a joint operation of the wind farm with a pumped hydro storage system to reduce risk and improve profits.FindingsThe results show that the (non-)consideration of seasonality of the monthly wind energy produced considerably influences the risk-return characteristics, but that principal developments dependent on input parameters and model variables remain similar.Originality/valueThis paper contributes to the literature by presenting different approaches for modeling the monthly wind energy produced based on direct models of the wind energy output, which are rare in the existing literature. Further, their impact on risk-return characteristics of a wind farm investment is analyzed, and thus, related model risk is assessed.