This is a joint project with the research group from TU Munchen
, particularly with Karl Bannoer
and Mathias Scherer
. In the financial world, there has been developed a rich zoo of different models which can be used for financial purposes. But one cannot be sure that the model is always suitable and, more microstructural, whether the model's parameters are correctly obtained. In some cases, during the financial crisis, the choice of not-suitable models has been isolated as one of the major sources of the distress for banks, e.g. the use of the Gaussian copula model. Hence, one is typically exposed to model uncertainty. In some cases, one might be able to assign probabilities to the different models, where one ends up with model risk. Recently, a number of authors addressed this issue. In contrast, model risk has not been discussed in the context of energy markets. However, taking into account the recent changes in the European Energy Market, in particular the German "Energiewende" it is clear that model risk is a pressing issue. On particular feature is the need for reinvestment (replacement investments and building more capacity) in the power plant park on Company and European level. The financial streams of such an investment can be generated on the market for energy derivatives in terms of spread options. For instance, a gas-fired power plants can be represented as a clean crack spread option, where the owner of such an option is long electricity and short gas and emission certificates. A positive investment decision is made in case such a contract is in the money, meaning that we observe a positive spread on the time interval under consideration. In terms of this project We aim to analyse the model risk inherent in such an investment decision.