Jumps and jolts: A continuous-time model for electricity future contract pricing

Abstract

This paper develops a continuous-time framework for pricing electricity future contracts that addresses key limitations of traditional models, particularly their inability to capture price spikes and shifts in hedging behavior. The proposed model incorporates both jump components and a time-varying drift to reflect dynamic changes in supply and demand for hedging. Additionally, correlated Brownian motions are included to capture common shocks across contracts with different delivery periods. Model parameters are estimated using the generalized method of moments (GMM) on daily settlement data from the Norwegian power market. Monte Carlo simulations confirm the consistency and robustness of the estimators. Out-of-sample forecasting exercises demonstrate superior predictive performance relative to standard ARMA-GARCH benchmarks. The results underscore the model’s practical relevance for traders and risk managers engaged in electricity portfolio management.