Valuation of transmission capacity rights; an option pricing approach with volatility estimation using Garch models for the France Spain case

Valuation of transmission capacity rights; an option pricing approach with volatility estimation using Garch models for the France Spain case

Tamayo Holguin, J.P.

Rodilla Rodríguez, P. (mentor)

Technology, Policy and Management

Policy Analysis

Engineering and Policy Analysis EMIN

2012-10-16

Transnational transmission presents a possible source of income for power producers and a way to decrease costs for consumers. The difference in neighboring countries' market prices encourages traders to profit from it by selling cheaper electricity in the market that has price it higher. Since the parties that own the transmission (TSOs) lines cannot generally participate in the market by regulation, they must allocate the Rights to transport electricity through transnational lines. Parties interested in these rights are usually power producers and other market agents seeking to exploit the rents that come from the price differences. Even though the auctioning of Transmission Rights (TRs) is not motivated by commercial interest, these rights have a commercial value. Then the issue becomes finding a way of valuing the asset according to benefits that it will generate in the future. One problem to deal with, consists in assessing how the agents in the system can hedge against the potential impact of transmission capacity constraints. Two simple ways to hedge against transmission congestion risk are the so-called Financial Transmission Right FTR one hand and the Physical Transmission Right PTR on the other. Both of them could be treated as financial instruments (options). In order to hedge the risk of a PTR an option pricing model can be used. Herein, for the particular case of France and Spain Interconnection was used the Margrabe formula for the exchange option with stochastic volatility by diagonal BEKK models. The model used here has a lot of properties that make it suitable for pricing it as a option, but also has some assumptions that usually don't hold in electricity prices. A more detailed study of the methodology could provide a tailored solution to this valuation problem. The model proposed by Cartea y González-Pedraz (2010), could be extended to the valuation of transmission rights and become able to price the option with zero strike price. This kind of model to derive a closed-form solution that allows for stochastic volatility has proven very difficult.

Transmission rights
Interconection Value
GARCH
Stochastic Volatility
Option Pricing

http://resolver.tudelft.nl/uuid:adda4a26-55fa-4fa2-99b2-3f747a742be6

Campus only

Student theses

master thesis

(c) 2012 Tamayo Holguin, J.P.