Portfolio management and performance improvement with Sharpe and Treynor ratios in electricity markets

Abstract

After 1980s, liberalization in energy industry accelerated. At that times, private sector started to show more tendency to electricity thanks to regulations and policies made by governments so electricity markets emerged and spread very rapidly, which created market risk that needs to be managed carefully along. Decision makers in electricity generation industry had to be faced this market risks besides other operational risks. They had to review policies regarding to risk management and they noticed that determining the right bidding strategy for electricity market and bilateral contract market was crucial. In this paper, Mean–variance, Semi-variance, and Down-side risk methods, which are common in portfolio optimization of financial literature are used to manage risk and to optimize electricity market bidding strategies and decision policy for an electricity generation company. Apart from the other limited studies, performances of optimal portfolio solutions are measured and further more improved with the help of Sharpe and Treynor ratios for electricity market. It is seen that direct use of portfolio management tools in electricity markets can cause sub-optimal solutions, so risk aversion constant of utility functions should be adapted. This study shows that optimal bidding strategies for electricity generators can be improved with the help of Sharpe and Treynor ratios. In order to demonstrate the results, two consecutive years of Turkish Day-ahead Market data are used in an empirical case study.