Application of Exotic Real Option for Electricity Market: Trial for Supply Function Bids Case

Real option theory has been widely applied for electricity asset valuation and investment issues. Since the supply function is the considerable bidding form of electricity market. Here we present a new exotic electricity real option tool in case of supply function bids for nowadays electricity market. Two typical electricity market bids forms- continuous and block bids curve- yielding the different nonlinear payoff function from that of standard Black Scholes formula are studied. The analytical formulas for this electricity option based on the classical Geometric Brownian motion and Mean reverting price process are explicitly derived. The test results by Monte Carlo simulation illustrate our formulas are correct. Our model and formula offer an important supplement for application of real option theory for electricity market.