The valuation of electricity cap contracts

Elliot Tonkes, presented at QANZIAM 2008 Conference, November 2008

This talk introduces an method for establishing the fair value of a cap contract which is an option of interest to players in the wholesale electricity market. The underlying approach is to tie the valuation to visible market signals, chiefly the forward price for swap contracts. It is clear that the Black-Scholes equation cannot be applied directly to electricity spot prices because the pool prices are not governed by regular probability distributions. However, the central limit theorem and a reformulation of the payoff in a Taylor expansion provides an avenue to recycle elements of the Black-Scholes framework.

Contact the author for further details.