CapOptix: An Options-Framework for Capacity Market Pricing

ArXiv ID: 2512.12871 “View on arXiv”

Authors: Millend Roy, Agostino Capponi, Vladimir Pyltsov, Yinbo Hu, Vijay Modi

Abstract

Electricity markets are under increasing pressure to maintain reliability amidst rising renewable penetration, demand variability, and occasional price shocks. Traditional capacity market designs often fall short in addressing this by relying on expected-value metrics of energy unserved, which overlook risk exposure in such systems. In this work, we present CapOptix, a capacity pricing framework that interprets capacity commitments as reliability options, i.e., financial derivatives of wholesale electricity prices. CapOptix characterizes the capacity premia charged by accounting for structural price shifts modeled by the Markov Regime Switching Process. We apply the framework to historical price data from multiple electricity markets and compare the resulting premium ranges with existing capacity remuneration mechanisms.

Keywords: Electricity Markets, Reliability Options, Markov Regime Switching, Capacity Pricing, Derivatives

Complexity vs Empirical Score

• Math Complexity: 8.5/10
• Empirical Rigor: 7.0/10
• Quadrant: Holy Grail
• Why: The paper employs advanced stochastic modeling (Markov regime-switching, jump-diffusions) and financial option theory with derivations, while empirically validating the framework using real-world electricity market data from multiple regions (NYISO, CAISO, ERCOT, Germany, Italy) and comparing premiums to existing mechanisms.

  flowchart TD
    Start["Research Goal: Develop a risk-sensitive capacity pricing framework for electricity markets"] --> DataInputs["Data & Inputs: Historical Price Data from Multiple Electricity Markets"]
    DataInputs --> Methodology["Methodology: Model Capacity as Reliability Options using Markov Regime Switching Process"]
    Methodology --> Computation["Computational Process: Simulate Price Regimes and Option Payoffs"]
    Computation --> Premiums["Output: Calculated Capacity Premiums"]
    Premiums --> Comparison["Analysis: Compare CapOptix Premiums with Existing Remuneration Mechanisms"]
    Comparison --> Outcomes["Key Findings: CapOptix accounts for structural price shifts and risk exposure, yielding premium ranges that differ from expected-value based mechanisms"]
    
    style Start fill:#e1f5e1,stroke:#333,stroke-width:2px
    style Outcomes fill:#fff3e0,stroke:#333,stroke-width:2px