Risk Measures in Energy Markets

Energy market players face a litany of risks and sources of uncertainty. It is therefore desirable that stochastic programming models describing and informing their decisions allow for risk-averse behaviour, with players sacrificing the prospect of extreme profits to mitigate against potential losses. Risk measures ranging from Value at Risk (VaR) and Conditional Value at Risk (CVaR) to expected shortfall, convex utility functions, and stochastic dominance constraints have been incorporated into energy market models to achieve this. This discussion provides an overview of these measures and a review of their implementation in existing energy literature. Alongside this is a discussion of Arrow–Debreu securities and their role in the hedging market. It additionally encompasses a sample optimisation problem comparing the distribution of profits caused by these risk measures for a player faced with stochastic costs. Furthermore, a sensitivity analysis of the parameters controlling these risk measures is provided. The discussion aims to illustrate the behaviour of the risk measures and elucidate those situations in which each would be applicable. This is valuable to those seeking to model energy markets credibly, particularly given the increasing uncertainty faced by such markets due to the transition to green and sustainable energy.