Predicting price spikes in electricity markets using a regime-switching model with time-varying parameters

This paper shows that a stochastic regime-switching model can represent the volatile behavior of wholesale electricity prices associated with price spikes effectively. The structure of the model is very flexible because the mean prices in the two regimes and the two transition probabilities are functions of the load and/or the implicit reserve margin. Using price data from the single settlement market in PJM (May 1999 to May 2000), the results show that the estimated switching probability from the low to the high regime predicts price spikes well if the reserve margin is measured accurately. (c) 2005 Elsevier B.V. All rights reserved.