The Influence of Temperature on Spike Probability in Day-Ahead Power Prices

It is well known that day-ahead prices in power markets exhibit spikes. These spikes are sudden increases in the day-ahead price that occur because power production is not flexible enough to respond to demand and/or supply shocks in the short term. This paper focuses on how temperature influences the probability on a spike. The paper shows that the difference between the actual and expected temperature significantly influences the probability on a spike and that the impact of temperature on spike probability depends on the season.Temperature;Day-ahead power price;Power production;Spike probability

Fat Tails in Power Prices

Spot power prices exhibit extreme price jumps and the tendency to oscillate around a long-term mean. Despite these well-known characteristics, electricity price models used for Monte Carlo simulations, VaR related measures, or derivatives valuation, often assume normally distributed residuals. In this paper, we examine the distributional characteristics of model residuals and show that the hypothesis of normality is rejected due to significant tail fatness and skewness. We then examine the Student-t distribution as a candidate fit for residuals and as an alternative distribution for random innovations in Monte Carlo simulations. The resulting price patterns clearly show that simulations based on the Student-t distribution resemble more closely actual power price patters. We then discuss the implications of our results for risk management.modelling;risk management;extreme value theory;Monte Carlo simulations;electricity price;spikes

Revisiting Uncovered Interest Rate Parity: Switching Between UIP and the Random Walk

In this paper, we examine in which periods uncovered interest rate parity was likely to hold. Empirical research has shown mixed evidence on UIP. The main finding is that it doesn’t hold, although some researchers were not able to reject UIP in periods with large interest differentials or high volatility. In this paper, we introduce a switching regime framework in which we assume that the exchange rate can switch between a UIP regime and a random walk regime. Our empirical results provide evidence that exchange rate movements were consistent with UIP over some periods, but not all. Consistent with the existing literature we also show that in periods with large interest differentials or increased exchange rate volatility, the exchange rate is more likely to follow UIP.Exchange rate dynamics;Uncovered interest rate parity;Markov regime switching

Regime Jumps in Electricity Prices

Electricity prices are known to be very volatile and subject to frequent jumps due to system breakdown, demand shocks, and inelastic supply. As many international electricity markets are in some state of deregulation, more and more participants in these markets are exposed to these stylised facts. Appropriate pricing, portfolio, and risk management models should incorporate these facts. Authors have introduced stochastic jump processes to deal with the jumps, but we argue and show that this specification might lead to problems with identifying the true mean-reversion within the process. Instead, we propose using a regime jump model that disentangles mean-reversion from jump behaviour. This model resembles more closely the true price path of electricity prices.stochastic models;electricity prices;international energy markets;jumps;mean reversion

Characterization of a Quantum Light Source Based on Spontaneous Parametric Down-Conversion

We have built a quantum light source capable of producing different types of quantum states. The quantum light source is based on entangled state preparation in the process of spontaneous parametric down-conversion. The single-photon detection rate of eight-hundred thousand per second demonstrates that we have created a bright state-of-the-art quantum light source. As a part of the characterization we measured two-photon quantum interference in a Hong-Ou-Mandel interferometer.Comment: 33 page

Measuring Credit Spread Risk

It is widely known that the small but looming possibility of defaultrenders the expected return distribution for financial productscontaining credit risk to be highly skewed and fat tailed. In thispaper we apply recent techniques developed for incorporating theadditional risk faced by changes in swap spreads. Using data from theUS, UK, Germany, and Japan, we find that the risk faced from largespread widenings and tightenings is grossly underestimated. Estimationof swap spread risk is dramatically improved when the severity of thefat tails is measured and incorporated into current estimationtechniques.value-at-risk;Market Risk;backtesting;extreme Value theory;parametric distributions

From Skews to a Skewed-t

In this paper we present a new methodology to infer the implied risk-neutral distribution function from European-style options. We introduce a skewed version of the Student-t distribution, whose main advantage is that its shape depends on only four parameters, of which two directly control for the levels of skewness and kurtosis. We can thus easily vary parameters to compare different distributions and use the parameters as inputs to price other options. We explain the method, provide some empirical results and compare them with the results of alternative models. The results indicate that our model provides a better fit to market prices of options than the Shimko or implied tree models, and has a lower computation time than most other models. We conclude that the skewed Student-t method provides a good alternative for European-style options.implied distribution;implied volatility;options;skewness;student-t

Option Formulas for Mean-Reverting Power Prices with Spikes

Electricity prices are known to be very volatile and subject tofrequent jumps due to system breakdown, demand shocks, and inelasticsupply. Appropriate pricing, portfolio, and risk management modelsshould incorporate these spikes. We develop a framework to priceEuropean-style options that are consistent with the possibility ofmarket spikes. The pricing framework is based on a regime jump modelthat disentangles mean-reversion from the spikes. In the model thespikes are truly time-specific events and therefore independent fromthe mean-reverting price process. This closely resembles thecharacteristics of electricity prices, as we show with Dutch APX spotprice data in the period January 2001 till June 2002. Thanks to theindependence of the two price processes in the model, we breakderivative prices down in a mean-reverting value and a spike value. Weuse this result to show how the model can be made consistent withforward prices in the market and present closed-form formulas forEuropean-style options.mean reversion;electricity price modelling;energy markets;option pricing;power spikes