This paper presents a real option valuation model of a power plant, which accounts for physical constraints and market incompleteness. Switching costs, minimum on-off times, ramp rates, or non-constant heat rates are important characteristics that can lead, if neglected, to overestimated values. The existence of non-hedgeable uncertainties is also a feature of energy markets that can impact assets value. We use the utility indifference approach to define the value of the physical asset. We derive the associated mixed optimal switching-control problem and provide a characterization of its solution by means of a coupled system of reflected Backward Stochastic Differential Equations (BSDE). We relate this system to a system of variational inequalities, and we provide a numerical comparative study by implementing BSDE simulation algorithms, and PDE finite differences schemes.
- Backward stochastic differential equation
- Finite differences for PDE
- Non-linear Monte Carlo methods
- Real option
- Utility indifference
ASJC Scopus subject areas
- Management Science and Operations Research