Polynomial Processes for Power Prices

Abstract

ABSTRACT Polynomial processes have the property that expectations of polynomial functions (of degree n, say) of the future state of the process conditional on the current state are given by polynomials (of degree ≤ n) of the current state. Here we explore the potential of polynomial maps of polynomial processes for modelling energy prices. We focus on the example of Alberta power prices, derive one- and two-factor models for spot prices. We examine their performance in numerical experiments, and demonstrate that the richness of the dynamics they are able to generate makes them well suited for modelling even extreme examples of energy price behaviour.