The Market Price of Jump Risk for Delivery Periods: Pricing of Electricity Swaps with Geometric Averaging

22 Mar 2023  ·  Annika Kemper, Maren Diane Schmeck ·

In this paper, we extend the market price of risk for delivery periods (MPDP) of electricity swap contracts by introducing a dimension for jump risk. As introduced by Kemper et al. (2022), the MPDP arises through the use of geometric averaging while pricing electricity swaps in a geometric framework. We adjust the work by Kemper et al. (2022) in two directions: First, we examine a Merton type model taking jumps into account. Second, we transfer the model to the physical measure by implementing mean-reverting behavior. We compare swap prices resulting from the classical arithmetic (approximated) average to the geometric weighted average. Under the physical measure, we discover a decomposition of the swap's market price of risk into the classical one and the MPDP.

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