We consider a slight perturbation of the Schwartz-Smith model for the electricity futures prices and the resulting modified spot model. Using the martingale property of the modified price under the risk neutral measure, we derive the arbitrage free model for the spot and futures prices. We estimate the parameters of the model by the method of maximum likelihood using the Kalman filter's estimate of the unobservable state variables, coupled with the usual statistical techniques. The main advantage of the new model is that it avoids the inclusion of artificial noise to the observation equation for the implementation of Kalman filter. The extra noise is build in within the model in an arbitrage free setting.
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