Capacity Investment Decisions in Equilibrium: A Distributionally Robust Approach

In electricity systems, investment in generation capacity is subject to risk. The distribution of uncertain parameters on which investment decisions depend might not be fully observed in historical values. In Europe, this was recently illustrated by the crisis of exceptionally high power prices during the 2021–2023 period, which was subsequently followed by a regime of extremely low and even negative prices. In that vein, although some models of risk aversion modify the distribution of realizations of random data, ambiguity aversion reflects a lack of confidence in this distribution and in its support. We study a competitive market with investors who are averse to ambiguity. Such a market is represented as an equilibrium model, where each agent solves a Wasserstein distributionally robust optimization problem regarding its investment decisions. Investments could be hedged by contracts. We derive a convex reformulation of the problem, demonstrate the existence of equilibria, and prove a version of the welfare theorem in this ambiguous context. Via simulations, we find that, as with risk aversion, ambiguity aversion results in capacity-investment deferrals. We show, however, that some financial contracts that could hedge the revenue of a risk-averse investor might not mitigate ambiguity. We also illustrate the difference between risk aversion and ambiguity aversion in our framework by comparing their respective worst-case distributions of uncertain data. Finally, we highlight that state-backed support schemes such as Contracts for Difference are welfare improving and capacity preserving under ambiguity.

Funding: This work was supported by the Grenoble Ecole de Management. The opinions expressed in this paper are those of the authors alone and might not represent the views of their institutions.

Supplemental Material: All supplemental materials, including the code, data, and files required to reproduce the results, are available at https://doi.org/10.1287/opre.2025.1769.