Closed-Form and Simulation Methods for Pricing Electricity Reliability Options

Summary

The paper treats reliability options as call-like contracts that power producers sell to system operators to support security of electricity supply. It derives closed-form valuation formulas under several assumptions about electricity prices and strike-price dynamics, then applies a real-market calibration using Italian power-market data.

Sensitivity analysis examines how option value responds to power-price and strike-price levels and volatility, their mean-reversion speeds, and the correlation between them. The description establishes a mathematical pricing framework and identifies the drivers it tests, but gives no formula details or quantitative findings. Its conclusions depend on the assumed price processes and the Italian calibration, so the results may not transfer unchanged to other market designs or regimes.

Key ideas

• Reliability options can be modeled as call options sold by power producers to system operators.
• The paper derives closed-form values under alternative assumptions for power and strike-price dynamics.
• An Italian power-market calibration is used to simulate option values.
• Sensitivity analysis considers price levels, volatility, mean reversion, and correlation.

Tags

# Pricing Reliability Options under different electricity prices' regimes


# Pricing Reliability Options under different electricity prices' regimes









Reliability Options are capacity remuneration mechanisms aimed at enhancing security of supply in electricity systems. They can be framed as call options on electricity sold by power producers to System Operators. This paper provides a comprehensive mathematical treatment of Reliability Options. Their value is first derived by means of closed-form pricing formulae, which are obtained under several assumptions about the dynamics of electricity prices and strike prices. Then, the value of the Reliability Option is simulated under a real-market calibration, using data of the Italian power market. We finally perform sensitivity analyses to highlight the impact of the level and volatility of both power and strike price, of the mean reversion speeds and of the correlation coefficient on the Reliability Options' value.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.