A Multi-Period Indifference-Based Equilibrium Approach to Modeling and Pricing Wind Speed Futures

Abstract

In recent years, there has been rising demand for commodity producers, industrial processors and speculators to hedge their risk on wind speed derivatives due to increased production of wind power in the energy market. This thesis prices wind speed futures in the illiquid wind derivatives market by extending the Lee and Oren indifference-based equilibrium pricing model for weather derivatives. The new model allows all players to speculate on the commodity markets and to maximize their short-term and long-term wealth from their financial investments and core business. The extended framework also examines the price effects of wind speed futures based in various geographic locations. A numerical example of the extended model in a 10-industry, 35-player market environment successfully yields rational wind speed futures prices and demonstrates that all players increase their wealth under the presence of wind speed futures.