Abstract
This paper presents a real option valuation model of a power plant, which accounts for physical constraints and market incompleteness. Switching costs, minimum on-off times, ramp rates, or non-constant heat rates are important characteristics that can lead, if neglected, to overestimated values. The existence of non-hedgeable uncertainties is also a feature of energy markets that can impact assets value. We use the utility indifference approach to define the value of the physical asset. We derive the associated mixed optimal switching-control problem and provide a characterization of its solution by means of a coupled system of reflected Backward Stochastic Differential Equations (BSDE). We relate this system to a system of variational inequalities, and we provide a numerical comparative study by implementing BSDE simulation algorithms, and PDE finite differences schemes.
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Porchet, A., Touzi, N. & Warin, X. Valuation of power plants by utility indifference and numerical computation. Math Meth Oper Res 70, 47–75 (2009). https://doi.org/10.1007/s00186-008-0231-z
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DOI: https://doi.org/10.1007/s00186-008-0231-z