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Inefficiencies and Market Power in Financial Arbitrage: A Study of California’s Electricity Markets

  • Christopher Knittel
  • Catherine Wolfram
  • James Bushnell
  • Severin Borenstein

    (Department of Economics, University of California Davis)

As with other commodities, electricity is often traded on both forward and spot markets. This was initially true in the restructured California electricity industry from 1998 to 2000. Though the power traded in the forward and spot markets was for delivery at the same times and locations, prices often differed in significant and predictable ways. We consider several explanations for this apparent inefficiency, concluding that uncertainty about regulatory penalties for trading in the spot market caused most firms to avoid trading on inter-market price differences. The few firms that did carry out these trades did not find it profit-maximizing to eliminate the price differences. Skyrocketing prices in the summer of 2000, however, changed the major buyers’ (utilities’) incentives and increased the price differentials between the markets.

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Paper provided by University of California, Davis, Department of Economics in its series Working Papers with number 630.

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Length: 44
Date of creation: 16 Nov 2006
Date of revision:
Handle: RePEc:cda:wpaper:06-30
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  1. Bushnell, James & Mansur, Erin T., 2005. "Consumption Under Noisy Price Signals: A Study of Electricity Retail Rate Deregulation in San Diego," Staff General Research Papers 13142, Iowa State University, Department of Economics.
  2. Eric Zitzewitz, 2003. "Who Cares About Shareholders? Arbitrage-Proofing Mutual Funds," Journal of Law, Economics and Organization, Oxford University Press, vol. 19(2), pages 245-280, October.
  3. David C. Parsley & Shang-Jin Wei, 1996. "Convergence to the Law of One Price Without Trade Barriers or Currency Fluctuations," NBER Working Papers 5654, National Bureau of Economic Research, Inc.
  4. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May.
  5. Kaminsky, Graciela, 1993. "Is There a Peso Problem? Evidence from the Dollar/Pound Exchange Rate, 1976-1987," American Economic Review, American Economic Association, vol. 83(3), pages 450-72, June.
  6. Bushnell, James & Wolfram, Catherine, 2008. "Electricity Markets," Staff General Research Papers 31547, Iowa State University, Department of Economics.
  7. Francis A. Longstaff & Ashley W. Wang, 2004. "Electricity Forward Prices: A High-Frequency Empirical Analysis," Journal of Finance, American Finance Association, vol. 59(4), pages 1877-1900, 08.
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