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Portfolio Risk in the Electricity Markets

Portfolio Risk in the Electricity Markets. Rene A. Carmona Bendheim Center for Finance Department of Operations Research & Financial Engineering Princeton University. Traditional Role of the Financial Engineer. New Instrument Valuation

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Portfolio Risk in the Electricity Markets

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  1. Portfolio Risk in the Electricity Markets Rene A. Carmona Bendheim Center for Finance Department of Operations Research & Financial Engineering Princeton University

  2. Traditional Role of the Financial Engineer • New Instrument Valuation • Take-or-pay, swing option, weather derivatives, gas storage,…. • Design and analysis of risk measures • VaR, Expected Shortfall, ….. Coherent measures of risk • Search for optimal hedging strategies • VaR hedging, Delta hedging, Delta-Gamma hedging, …. • Incomplete markets • Stochastic volatility, jump diffusions, ….. • Dynamic hedging for buyers and sellers • Indifference pricing

  3. FE for the New Power Markets • Credit Rating Free-Fall • Could Clearing be a Solution ? • Benchmark for Collateral Posting

  4. Credit Rating Downgrades • Modeling illiquidity • Understanding credit migration • Including counterparty risk in valuation • Hedging with credit derivatives

  5. Could Clearing be a Solution? • Need for standardized instruments • Exchange traded instruments are standardized • OTC are not • Design of a minimal set of instruments • from which most instruments could be synthesized • Industry loves tailor made contracts

  6. Collateral Requirements / Margin Calls • Frequent Marks to Market • Objective valuation algorithms widely accepted • Netting or not Netting (that is the question) • Challenge of the quantification of dependencies • Correlations, copulas, ….. • Integrated approach to risk control • Distributed optimization

  7. Conclusions • Think Probabilistically • Estimate Properly the Distribution Tails • Use the Right Tools to Quantify Dependencies

  8. Operations Research & Financial Engineering Princeton University Bendheim Center for Finance

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