A Smooth Transition Logit Model of the Effects of Deregulation in the Electricity Market

The paper proposes and develops a smooth transition logit (STL) model that is designed to detect and model situations in which there is structural change in the behaviour underlying the latent index from which the binary dependent variable is constructed. The maximum likelihood estimators of the parameters of the model are derived along with their asymptotic properties and a Lagrange Multiplier test of the null hypothesis of linearity in the underlying latent index. The development of the STL model is motivated by the desire to assess the impact of deregulation in the Queensland electricity market by addressing the question of whether or not increased competition has resulted in changes in the behaviour of the spot price of electricity, specifically with respect to the well documented phenomenon of periodic abnormally high prices or price spikes. In testing this conjecture the STL model allows the timing of any change to be endogenously determined and also market participants' behavior to change gradually over time. The main results reported in the paper provide clear evidence in support of the structural change in nature and duration of price spikes in Queensland. The endogenous dating of the structural change by the STL model agrees with the institutional detail surrounding the process of deregulation and indicates that the full effect of the policy change took about a year to occur. Notwithstanding the fact that the STL model was specifically developed to tackle a problem couched in an Australian institutional framework this research will be of general interest and applicability. In particular, it is applicable to any situation in which the impact and dating of policy changes is required and where the outcome of the policy is naturally measurable as a binary variable.