The impact of investors' risk aversion on the performances of capacity remuneration mechanisms

Abstract

This paper analyses the impact of risk aversion on the performances of capacity remuneration mechanisms, with investors facing an uncertain peak load. Three market designs are studied for this purpose: a competitive energy only market, a capacity market and a strategic reserve mechanism. A simulation model based on system dynamics is developed in order to represent investment decisions and analyse the behaviour of each market design. Risk aversion is modelled through the computation of Conditional Value at Risk. The results are discussed in terms of impact on the reliability (ability to limit shortages) and cost (total generation costs) of the studied market designs. When comparing the three market designs, the capacity market seems to be the least affected by the introduction of risk aversion, both in terms of cost and reliability. This result suggests that implementing a capacity market is preferable in order to deal with the adverse effects of risk aversion, given the simulations and parameters that were used.