Locational price spreads and the pricing of contracts for difference: Evidence from the Nordic market
AbstractIn electricity markets, not only does the risk of substantial price variations over time exist, but so does the risk of price variations over space, as prices between locations can differ due to transmission congestion. To manage this risk, Contracts for Difference (CfDs), i.e., forwards on the spread between a particular area price and the (unconstrained) system price, were introduced at the Scandinavian electricity exchange Nord Pool at the end of 2000. We empirically investigate the pricing of these CfDs over the period 2001 through 2006 and find that CfD prices contain significant risk premia. Their sign and magnitude, however, differ substantially between areas and delivery periods, because areas are subject to transmission congestion to a varying extent. While the relation between risk premia and time-to-maturity is not uniform for CfDs, there is a negative relation for implied area and system forwards, which can be explained by the relative hedging demand of market participants. In addition, we find that risk premia of CfDs and implied area forwards vary systematically with the variance and skewness of the underlying spot prices. This confirms both implications of the Bessembinder and Lemmon [Bessembinder, H., Lemmon, M.L., 2002. Equilibrium pricing and optimal hedging in electricity forward markets. Journal of Finance, 57, 1347-1382] model.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
Bibliographic InfoArticle provided by Elsevier in its journal Energy Economics.
Volume (Year): 31 (2009)
Issue (Month): 2 (March)
Contact details of provider:
Web page: http://www.elsevier.com/locate/eneco
Electricity Contract for Difference Implied area forward Risk premium;
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- De Vany, Arthur S. & Walls, W. David, 1999. "Cointegration analysis of spot electricity prices: insights on transmission efficiency in the western US," Energy Economics, Elsevier, vol. 21(5), pages 435-448, October.
- Karakatsani, Nektaria V. & Bunn, Derek W., 2008. "Intra-day and regime-switching dynamics in electricity price formation," Energy Economics, Elsevier, vol. 30(4), pages 1776-1797, July.
- Worthington, Andrew & Kay-Spratley, Adam & Higgs, Helen, 2005.
"Transmission of prices and price volatility in Australian electricity spot markets: a multivariate GARCH analysis,"
Elsevier, vol. 27(2), pages 337-350, March.
- Andrew C. Worthington & Adam Kay-Spratley & Helen Higgs, 2002. "Transmission of prices and price volatility in Australian electricity spot markets: A multivariate GARCH analysis," School of Economics and Finance Discussion Papers and Working Papers Series 114, School of Economics and Finance, Queensland University of Technology.
- Benth, Fred Espen & Cartea, Álvaro & Kiesel, Rüdiger, 2008.
"Pricing forward contracts in power markets by the certainty equivalence principle: Explaining the sign of the market risk premium,"
Journal of Banking & Finance,
Elsevier, vol. 32(10), pages 2006-2021, October.
- Fred Espen Benth & Alvaro Cartea & Ruediger Kiesel, 2006. "Pricing Forward Contracts in Power Markets by the Certainty Equivalence Principle: Explaining the Sign of the Market Risk Premium," Birkbeck Working Papers in Economics and Finance 0611, Birkbeck, Department of Economics, Mathematics & Statistics.
- Haldrup, Niels & Nielsen, Morten Orregaard, 2006.
"A regime switching long memory model for electricity prices,"
Journal of Econometrics,
Elsevier, vol. 135(1-2), pages 349-376.
- Niels Haldrup & Morten O. Nielsen, 2004. "A Regime Switching Long Memory Model for Electricity Prices," Economics Working Papers 2004-2, School of Economics and Management, University of Aarhus.
- Hendrik Bessembinder & Michael L. Lemmon, 2002. "Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets," Journal of Finance, American Finance Association, vol. 57(3), pages 1347-1382, 06.
- Diko Pavel & Lawford Steve & Limpens Valerie, 2006. "Risk Premia in Electricity Forward Prices," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 10(3), pages 1-24, September.
- Richard Green, 2007. "Nodal pricing of electricity: how much does it cost to get it wrong?," Journal of Regulatory Economics, Springer, vol. 31(2), pages 125-149, April.
- Dusak, Katherine, 1973. "Futures Trading and Investor Returns: An Investigation of Commodity Market Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 81(6), pages 1387-1406, Nov.-Dec..
- Chao, Hung-Po & Peck, Stephen, 1996. "A Market Mechanism for Electric Power Transmission," Journal of Regulatory Economics, Springer, vol. 10(1), pages 25-59, July.
- Nils-Henrik M. von der Fehr, Eirik S. Amundsen and Lars Bergman, 2005.
"The Nordic Market: Signs of Stress?,"
The Energy Journal,
International Association for Energy Economics, vol. 0(Special I), pages 71-98.
- von der Fehr, N-H.M. & Amundsen , E.S. & Bergman, L., 2005. "The Nordic Market: Signs of Stress?," Cambridge Working Papers in Economics 0525, Faculty of Economics, University of Cambridge.
- M. von der Fehr, Nils-Henrik & Amundsen, Eirik S. & Bergman, Lars, 2004. "The Nordic Market: Signs Of Stress?," Working Papers in Economics 15/04, University of Bergen, Department of Economics.
- Haldrup Niels & Nielsen Morten Ø., 2006.
"Directional Congestion and Regime Switching in a Long Memory Model for Electricity Prices,"
Studies in Nonlinear Dynamics & Econometrics,
De Gruyter, vol. 10(3), pages 1-24, September.
- Haldrup; Niels & Morten Oerregaard Nielsen, 2005. "Directional Congestion and Regime Switching in a Long Memory Model for Electricity Prices," Economics Working Papers 2005-18, School of Economics and Management, University of Aarhus.
- Hogan, William W, 1992. "Contract Networks for Electric Power Transmission," Journal of Regulatory Economics, Springer, vol. 4(3), pages 211-42, September.
- Moulton, Jonathan S., 2005. "California electricity futures: the NYMEX experience," Energy Economics, Elsevier, vol. 27(1), pages 181-194, January.
- Kristiansen, T., 2004. "Pricing of Contracts for Difference in the Nordic market," Energy Policy, Elsevier, vol. 32(9), pages 1075-1085, June.
- Kamara, Avraham & Siegel, Andrew F, 1987. " Optimal Hedging in Futures Markets with Multiple Delivery Specifications," Journal of Finance, American Finance Association, vol. 42(4), pages 1007-21, September.
- Emile J. Brinkmann & Ramon Rabinovitch, 1995. "Regional Limitations on the Hedging Effectiveness of Natural Gas Futures," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 113-124.
- Chi-Keung Woo, Ira Horowitz, Brian Horii, Ren Orans, and Jay Zarnikau, 2012. "Blowing in the Wind: Vanishing Payoffs of a Tolling Agreement for Natural-gas-fired Generation of Electricity in Texas," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1).
- Pietz, Matthäus, 2009. "Risk premia in the German electricity futures market," CEFS Working Paper Series 2009-07, Center for Entrepreneurial and Financial Studies (CEFS), Technische Universität München.
- Pietz, Matthäus, 2009. "Risk premia in electricity wholesale spot markets: empirical evidence from Germany," CEFS Working Paper Series 2009-11, Center for Entrepreneurial and Financial Studies (CEFS), Technische Universität München.
- Woo, C.K. & Zarnikau, J. & Moore, J. & Horowitz, I., 2011. "Wind generation and zonal-market price divergence: Evidence from Texas," Energy Policy, Elsevier, vol. 39(7), pages 3928-3938, July.
- Frestad, Dennis, 2012. "Liquidity and dirty hedging in the Nordic electricity market," Energy Economics, Elsevier, vol. 34(5), pages 1341-1355.
- Cartea, Álvaro & González-Pedraz, Carlos, 2012.
"How much should we pay for interconnecting electricity markets? A real options approach,"
Elsevier, vol. 34(1), pages 14-30.
- Álvaro Cartea & Carlos González-Pedraz, 2010. "How much should we pay for interconnecting electricity markets? A real options approach," Business Economics Working Papers wb103206, Universidad Carlos III, Departamento de Economía de la Empresa.
- Ferkingstad, Egil & Løland, Anders & Wilhelmsen, Mathilde, 2011. "Causal modeling and inference for electricity markets," Energy Economics, Elsevier, vol. 33(3), pages 404-412, May.
- Frestad, Dennis, 2010. "Corporate hedging under a resource rent tax regime," Energy Economics, Elsevier, vol. 32(2), pages 458-468, March.
- Lindström, Erik & Regland, Fredrik, 2012. "Modeling extreme dependence between European electricity markets," Energy Economics, Elsevier, vol. 34(4), pages 899-904.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).
If references are entirely missing, you can add them using this form.