Discussion Paper Details

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Title: Investment Incentives and Auction Design in Electricity Markets

Author(s): Maria-Angeles de Frutos, Natalia Fabra and Nils-Henrik M Von der Fehr

Publication Date: January 2008

Keyword(s): electricity, investment, market design, regulatory reform and uniform price and discriminatory auctions

Programme Area(s): Industrial Organization

Abstract: Motivated by the regulatory debate in electricity markets, we seek to understand how market design affects market performance through its impact on investment incentives. For this purpose, we study a two-stage game in which firms choose their capacities under demand uncertainty prior to bidding into the spot market. We analyse a number of different market design elements, including (i) two commonly used auction formats, the uniform-price and discriminatory auctions, (ii) price-caps and (iii) bid duration. We find that, although the discriminatory auction tends to lower prices, this does not imply that investment incentives at the margin are poorer; indeed, under reasonable assumptions on the shape of the demand distribution, the discriminatory auction induces (weakly) stronger investment incentives than the uniform-price format.

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Bibliographic Reference

de Frutos, M, Fabra, N and Von der Fehr, N. 2008. 'Investment Incentives and Auction Design in Electricity Markets'. London, Centre for Economic Policy Research.