Stochastic price modelling of high volatility, mean-reverting, spike-prone commodities: The Australian wholesale electricity market

H. Higgs, Griffith University
A. C. Worthington, University of Wollongong

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This paper was originally published as Higgs, H and Worthington, AC, Stochastic price modelling of high volatility, mean-reverting, spike-prone commodities: The Australian wholesale electricity market University of Wollongong, School of Accounting and Finance Working Paper Series No. 06/02, 2006.

Abstract

It is commonly known that wholesale spot electricity markets exhibit high price volatility, strong mean-reversion and frequent extreme price spikes. This paper employs a basic stochastic model, a mean-reverting model and a regime-switching model to capture these features in the Australian national electricity market (NEM), comprising the interconnected markets of New South Wales, Queensland, South Australia and Victoria. Daily spot prices from 1 January 1999 to 31 December 2004 are employed. The results show that the regimeswitching model outperforms the basic stochastic and mean-reverting models. Electricity prices are also found to exhibit stronger mean-reversion after a price spike than in the normal period, and price volatility is more than fourteen times higher in spike periods than in normal periods. The probability of a spike on any given day ranges between 5.16 percent in NSW to 9.44 percent in Victoria.