Modeling power forward prices for power spot prices with upward and downward spikes in the framework of the non-Markovian approach

Abstract

As power markets are becoming deregulated worldwide, the modeling of the dynamics of power forward prices is becoming a key problem in energy risk management, physical assets valuation and derivatives pricing. In this paper we present and further develop a new approach to modeling power spot prices with spikes proposed earlier by the author. In contrast to other approaches, we model power spot prices with spikes as a non-Markovian stochastic process that allows for a unified modeling of positive and negative power spot prices as well as upward and downward spikes directly as self-reversing jumps. We show how this approach can be used for a unified modeling of positve and negative power forward prices for positive and negative power spot prices with upward and downward spikes in the practically important special case of the upward and downward Pareto distributions for the magnitude of upward and downward spikes.