Modelling electricity forward curve dynamics in the Italian market

In this paper we discuss the modelling of electricity contracts traded in the Italian market. We directly model the forward price of the electricity. We apply the Heath Jarrow Morton model in order to simulate the forward rate dynamics and evaluate first the forward price with instantaneous delivery time and then the "swap price" with delivery over a period. We use a regime-switching model to introduce jumps and spikes that depend on the state of the system. Thus the model describes the properties of the electricity price dynamics both in a base stable regime and in a spike regime. A numerical algorithm is developed to simulate swap price trajectories.