Workgroup Financial Mathematics

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Modeling spot price dependence in Australian electricity markets with applications to risk management (Stefan Trueck)


We examine the dependence structure of electricity spot prices across regional markets in the Australian National Electricity Market (NEM). Our analysis is based on a GARCH approach to model the time-varying volatility of the marginal price series in the considered regions in combination with copulae to capture the dependence structure between the different markets. We apply different copula models including both one-parametric and copula mixture models. We find a positive dependence structure between the prices from all of the considered markets, while the strongest dependence is usually exhibited between markets that are connected via interconnector transmission lines. Regarding the nature of dependence, among the one-parametric copulas, the Student-t copula provides the best fit and tends  to outperform all other one-parametric approaches. On the other hand, the overall best results are obtained using mixture models due to their ability of also capturing asymmetric dependence in the tails of the distribution. We find significant tail dependence between Australian wholesale electricity prices, indicating that especially extreme observations like price spikes may happen jointly across regional markets. Examining the Value-at-Risk of stylized portfolios constructed from electricity spot contracts in different regional markets, we find that the Student-t and mixture copula models outperform the Gaussian copula in a backtesting study. Our results are important for the risk management and hedging of market participants, in particular for those operating in several regional markets simultaneously.