Using market simulation to manage price risk in a centrally cleared market

Risk management is needed to quantify and mitigate the price risk associated with uncertain prices. Electricity prices in competitive markets display a very high short-term volatility. This volatility results in part from the fact that the electrical system has physical constraints such that failures of system devices cause sharp changes in the available supply. Managing price risk requires a statistical forecast for the expected range of prices for electricity. This forecast must involve simulation of the market to capture physical and financial effects. Value-at-risk is an established method for measuring the risk a company is exposed to for price changes. A fundamental component of risk management is forecasting market prices including variances. This presentation introduces established concepts of value-at-risk analysis for electricity markets and proposes a methodology for simulation of the underlying physical market.