Hedging Strategy and Electricity Contract Engineering - IFOR

66 Risk management
tG T V r S tG T V for most risk measure, such as variance, VaR and CVaR,
RS
since variance grows linear in time. 10 For other underlying price processes,
which are not stationary, as is the case in the electricity market with its seasonality
and mean reversion, the statement made above about the overall risk
tG T V is not obvious anymore. In any case the measurement of the intermediate
risks S r GuuV t can give additional information on how much capital that is
RS
needed in each period as insurance against adverse market movements. 11 The
intermediate risks together with knowledge about certain cash flows affecting
the capital base can give insight in how a firm best can utilize the risk during
the horizon.
The risk models used today in practice are static in the sense that they by nature
are one-periodic. The portfolio is assumed to be constant over the whole period.
This type of model is not forward looking, since it does not care about how the
risk evolves over time. One approach to investigate the dynamics of the risk,
would be to study the process S kG r V T tG for T . It should be noted that the
risk itself will be a random variable for f‘ t , which complicates the picture.
Although a complex task, measuring the risk in a multi-periodic set up could
add important aspects to risk management for financial portfolios in general
and for electricity portfolios with their long liquidation times in particular. We
will not go further into multi period risk management, but note that it is an area
for future research. For more information on multi-period risk, see Artzner et
al. [ADEH01].
3.7. Valuation models
There are two groups of valuation models to assess financial contracts. One
group is the valuation models that use absence of arbitrage to value contracts
in terms of other assets. The other group contains the valuation models that
derive the value from an economic equilibrium.
10 Observe that VaR and CVaR for normally distributed returns are given by a scaling of
the standard deviation.
11 Corresponds to the regulatory capital in the banking sector.