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Risk Management in Electricity Markets: Hedging and Market Incompleteness

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Author Info

  • Willems, Bert
  • Morbee, J.

    (Tilburg University, Tilburg Law and Economics Center)

Abstract

Abstract: The high volatility of electricity markets gives producers and retailers an incentive to hedge their exposure to electricity prices. This paper studies how welfare and investment incentives are affected when markets for derivatives are introduced, and to what extent this depends on market completeness. First, we show that aggregate welfare in the market increases with the number of derivatives offered. If firms have liquidity constraints, option markets are particularly attractive from a welfare point of view. Second, we demonstrate that increasing the number of derivatives improves investment decisions of small firms, because additional financial markets signal how firms can reduce overall sector risk. Finally, we show that government intervention may be needed, because private investors may not have the right incentives to create the optimal number of markets.

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Bibliographic Info

Paper provided by Tilburg University, Tilburg Law and Economic Center in its series Discussion Paper with number 2008-031.

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Date of creation: 2008
Date of revision:
Handle: RePEc:dgr:kubtil:2008031

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Web page: http://www.tilburguniversity.nl/tilec/

Related research

Keywords: Electricity markets; Financial Markets; Investments;

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Cited by:
  1. Willems, Bert & De Corte, Emmanuel, 2008. "Market power mitigation by regulating contract portfolio risk," Energy Policy, Elsevier, vol. 36(10), pages 3787-3796, October.
  2. van der Weijde, A.H. & Hobbs, B.F., 2011. "Planning electricity transmission to accommodate renewables: Using two-stage programming to evaluate flexibility and the cost of disregarding uncertainty," Cambridge Working Papers in Economics 1113, Faculty of Economics, University of Cambridge.

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