Electricity Derivatives: Numerical Methods for Derivatives Pricing

In the previous chapter we have seen that, for various reasons, no closed-form pricing formulas are available for the pricing of electricity derivatives, at least if we concentrate on realistic pricing approaches. Not even the simplest plain-vanilla instruments can be priced realistically by means of a traditional Black–Scholes-type model, because of the particular features which characterize the stochastic dynamics of electricity spot and forward prices. Hence, numerical procedures have to be used in order to determine electricity derivative prices and analytical risk measures, such as Greeks. In this chapter we will discuss general numerical procedures for derivative pricing such as Monte Carlo simulations and Lattice methods, presenting also some practical pricing applications related to derivative instruments introduced in previous chapters.