Introducing Cycle Analysis and Monte Carlo Simulations

Joaquin Narro and Monica Caamano

In this chapter, we show how a systematic model can be built by unearthing inefficiencies using cycle analysis, blending in Monte Carlo methods, to simulate the expected values of a trading strategy we wish to systematise. Duality exists when there is confirmation of two different regimes, and it is often evidenced by the display of heavy-tailed price behaviour at times, followed by periods of sustained lower volatility (Karakatsani and Bunn, 2010; Bessec and Bouabdallah, 2005). Quantitatively, heavy-tailed behaviour is associated with a price distribution that displays a higher probability of significantly higher (or lower) results when these are compared to a normal distribution.

In the following sections, we will describe a specific example involving short-term German electricity prices introducing the necessary market background and mathematical concepts as we go along. We will illustrate the process with an example concerning the duality of volatility regimes in short-term electricity markets against a backdrop of growing integration of renewables generation.

UNDERSTANDING THE ELECTRICITY MARKET BACKGROUND

We should clearly differentiate between spot and forward