Abstract
We present the closed-form solution to the problem of hedging price and quantity risks for energy retailers (ER), using financial instruments based on electricity price and weather indexes. Our model considers an ER who is intermediary in a regulated electricity market. ERs buy a fixed quantity of electricity at a variable cost and must serve a variable demand at a fixed cost. Thus ERs are subject to both price and quantity risks. To hedge such risks, an ER could construct a portfolio of financial instruments based on price and weather indexes. We construct the closed form solution for the optimal portfolio for the mean-VaR model in the discrete setting. Our model does not make any distributional assumption.
Highlights
The electric power sector includes the generation, transmission, distribution and commercialization of electric power
Electric power generators have warned of the risk that the existence of agents, who had agreed on long-term contracts without a real electric endorsement and used the electric financial market as an instrument to comply with their contractual obligations, could have on the future feasibility of the electric wholesale market
This paper develops numerical methods to determine the optimal derivative contingent claim written on both electricity price and a weather; aiming to improve the performance of the hedging claim due to the link between price, demanded quantity and weather-linked index
Summary
The electric power sector includes the generation, transmission, distribution and commercialization of electric power. As price and quantity in the electricity markets are correlated with weather, financial instruments based on weather could be used to hedge price and volumetric risks. The use of weather derivatives offers the chance to hedge against weather related risks in electric power markets Companies hedge their portfolios against unexpected weather variations using contracts that are not correlated with classical financial assets, but are based on weather-linked indexes instead. This contracts allow the agents to transfer their risks exposures to financial markets, using financial instruments to hedge price and quantity fluctuations via climatic fluctuations. This paper exploits the convexity of the Mean-Variance utility function, which makes possible to find a global optimum to the posed optimization model (Boyd and Vandenberghe 2004)
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