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The overnight risk premium in electricity forward contracts

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  • Fleten, Stein-Erik
  • Hagen, Liv Aune
  • Nygård, Maria Tandberg
  • Smith-Sivertsen, Ragnhild
  • Sollie, Johan M.

Abstract

We analyze the risk premium on electricity forward contracts traded for the Nordic and German/Austrian electricity markets. We argue that finding risk premiums by analyzing overnight returns is more relevant than the frequently used ex post approach. The derivatives in these markets can be characterized as trading products and hedging products. Each contract shows a clear increase in trading volume and liquidity when approaching maturity. We link this to a testable hypothesis where financial traders are compensated for holding price risk, and where the sign and magnitude of the risk premium changes depending on the hedging pattern of producers and retailers. Incorporating this in regressions we find that there are higher risk premiums in the period before the forwards become front products, compared to the risk premiums in the front period. Quarterly and monthly contracts show the most significant results.

Suggested Citation

  • Fleten, Stein-Erik & Hagen, Liv Aune & Nygård, Maria Tandberg & Smith-Sivertsen, Ragnhild & Sollie, Johan M., 2015. "The overnight risk premium in electricity forward contracts," Energy Economics, Elsevier, vol. 49(C), pages 293-300.
    • Handle: RePEc:eee:eneeco:v:49:y:2015:i:c:p:293-300
    DOI: 10.1016/j.eneco.2014.12.022
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    References listed on IDEAS

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    Cited by:

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    3. Koten, Silvester Van, 2020. "Forward premia in electricity markets: A replication study," Energy Economics, Elsevier, vol. 89(C).
    4. Marius Paschen, 2016. "The effect of intermittent renewable supply on the forward premium in German electricity markets," Working Papers V-397-16, University of Oldenburg, Department of Economics, revised Nov 2016.
    5. Claudio Monteiro & L. Alfredo Fernandez-Jimenez & Ignacio J. Ramirez-Rosado, 2020. "Predictive Trading Strategy for Physical Electricity Futures," Energies, MDPI, vol. 13(14), pages 1-24, July.
    6. Spodniak, Petr & Collan, Mikael, 2018. "Forward risk premia in long-term transmission rights: The case of electricity price area differentials (EPAD) in the Nordic electricity market," Utilities Policy, Elsevier, vol. 50(C), pages 194-206.
    7. Bevin-McCrimmon, Fergus & Diaz-Rainey, Ivan & McCarten, Matthew & Sise, Greg, 2018. "Liquidity and risk premia in electricity futures," Energy Economics, Elsevier, vol. 75(C), pages 503-517.

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    More about this item

    Keywords

    Risk premium estimation; Electricity markets; Forward markets; Liquidity premium; Electricity swaps; Front product effect;
    All these keywords.

    JEL classification:

    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations

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