The fine structure of electricity price volatility

TL;DR

This paper rigorously analyzes electricity price volatility across three European zones using a stochastic PDE framework, revealing distinct drivers and the absence of asymmetric shocks after conditioning on state variables.

Contribution

It introduces a novel estimation approach for weekly integrated variance of electricity prices based on a stochastic PDE model, addressing infinite-dimensional complexities.

Findings

Different volatility drivers identified for Germany, Norway, and Spain.

Generation variables influence volatility differently across zones.

Leverage effects are not present once conditioned on state variables.

Abstract

We conduct the first rigorous study of electricity price volatility for the full panel of electricity prices across three European generation zones. By interpreting the observed day-ahead prices as local averages of a latent price process governed by a stochastic partial differential equation, we develop estimators of the weekly integrated variance. The inherently infinite dimensional setting introduce several complications that are not relevant in the conventional finite dimensional semimartingale setting, and we spend considerable effort in dealing with these. In particular, we must account for both mean-reversion in prices and semigroup-smoothing in the estimated variance. We provide a detailed decomposition and interpretation of the empirical estimates across three vastly different European generation zones, namely Germany, Norway, and Spain. Our findings indicate that each zone has very different drivers of volatility, and that the impact of generation variables differs considerably. We document that leverage effects appear to be present at first sight, but disappear once we condition on suitable state variables, thereby showing that electricity price volatility does not generally exhibit asymmetric responses to price shocks.