Insurance Contracts for Hedging Wind Power Uncertainty

Abstract

This paper presents an insurance contract that the supplier of wind power may subscribe to with an insurance company in order to immunize his/her revenue against the volatility of wind power and prices. Based on empirical evidence, we found that wind power and electricity prices are correlated. Then, we adopted a joint stochastic process to model both time series, which is based on indexed semi-Markov chains for the wind power generation process and on a general Markovian process for the electricity price process. Using a joint stochastic model allows the insurance company to compute the fair premium that the wind power producer has to pay in order to hedge the risk against inadequate revenues. Recursive type equations are obtained for the prospective mathematical reserves of the insurance contract. The model and the validity of the results are illustrated through a real data application.