Multi layer model for correlated energy prices

In this booklet we develop an extension of the affine jump–diffusion modeling framework and use it to build an intuitive and tractable model of an energy price complex. The development is motivated by the need to model prices of electricity while capturing their dependence on the price of other energy commodities. Such a model is essential for valuing a range of typical derivatives traded in the electricity markets: cross-commodity spread options cross-location spread options fuel-switching powerplants etc. We give an approximate pricing method for these derivatives together with precise error bound estimates.