Modeling Dependence of Price Spikes in Australian Electricity Markets

Abstract

Price spikes are of particular importance due to their severe impacts on consumers, businesses and industry. They constitute a major source of price risk to market participants, e.g., electricity retailers with commitments to meet customers' daily electricity demands. To those trading in several electricity markets simultaneously, the probability of simultaneous price spikes termed as tail dependence is of great importance when computing risks. For this purpose, the problem of modeling joint price spikes in the Australian electricity market is considered. A common measure of tail dependence measure is the so-called tail dependence coefficient (TDC). We present a nonparametric estimator of the tail dependence and further, the point estimation is complemented with an hypotheses test. We find significant tail dependence in electricity prices that cannot be ignored. Accurate characterization of this tail dependence is important for a variety of risk management purposes. These include hedging activities of market participants.