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Risk aversion and generation adequacy in liberalized electricity markets: Benefits of capacity markets

This paper analyzes the impact of investors' risk aversion on investments in generation capacity. This effect is investigated in two different market designs, namely a competitive energy-only market and a capacity market. A simulation model, based on system dynamics, in which risk averse investors and an uncertain peak load are represented, is used to this end. The results are discussed in terms of impact on the effectiveness and efficiency of the studied market designs. The effectiveness of a market design is defined as its ability to avoid shortages and the efficiency is linked to the total generation costs. When comparing the performances of the two market designs in a situation of risk aversion, the capacity market proves to be more robust, especially regarding effectiveness. Furthermore, the results suggest that, in presence of risk averse investors, implementing a capacity market yields even higher benefits, compared to a risk neutral situation.