A numerical algorithm for pricing electricity derivatives for jump-diffusion processes based on continuous time lattices

► Numerical algorithm to approximate stochastic processes with asymmetric jumps. ► Based on continuous time Markov chain approximation. ► Numerical study of convergence for the case of Merton jump-diffusion. ► Application to calibrated Geman-Roncoroni model of electricity prices. We present a numerical algorithm for pricing derivatives on electricity prices. The algorithm is based on approximating the generator of the underlying price process on a lattice of prices, resulting in an approximation of the stochastic process by a continuous time Markov chain. We numerically study the rate of convergence of the algorithm for the case of the Merton jump-diffusion model and apply the algorithm to calculate prices and sensitivities of both European and Bermudan electricity derivatives when the underlying price follows a stochastic process which exhibits both fast mean-reversion and jumps of large magnitude.