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

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Listed:
  • Borenstein, Severin
  • Bushnell, James
  • Knittel, Chris
  • Wolfram, Catherine

Abstract

For two years prior to the collapse of Californiaï¾’s restructured electricity market, power traded in both a forward and a spot market for delivery at the same times and locations. Nonetheless, prices in the two markets often differed in significant and predictable ways. This apparent inefficiency persisted, we argue, because most firms believed that trading on inter-market price differences would yield regulatory penalties. For the few firms that did make such trades, it was not profit- maximizing to eliminate the price differences entirely. Skyrocketing prices in 2000 changed the major buyersï¾’ (utilitiesï¾’) incentives and exacerbated the price differentials between the markets.

Suggested Citation

  • Borenstein, Severin & Bushnell, James & Knittel, Chris & Wolfram, Catherine, 2008. "Inefficiencies and Market Power in Financial Arbitrage: A Study of California's Electricity Markets," Staff General Research Papers Archive 13133, Iowa State University, Department of Economics.
  • Handle: RePEc:isu:genres:13133
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    References listed on IDEAS

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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 Archive 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," The Quarterly Journal of Economics, Oxford University Press, vol. 111(4), pages 1211-1236.
    4. 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 450-472, June.
    5. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    6. Bushnell, James & Wolfram, Catherine, 2008. "Electricity Markets," Staff General Research Papers Archive 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, August.
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    Citations

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    Cited by:

    1. Paschmann, Martin, 2017. "Economic Analysis of Price Premiums in the Presence of Non-convexities - Evidence from German Electricity Markets," EWI Working Papers 2017-12, Energiewirtschaftliches Institut an der Universitaet zu Koeln (EWI).
    2. Koichiro Ito & Mar Reguant, 2016. "Sequential Markets, Market Power, and Arbitrage," American Economic Review, American Economic Association, vol. 106(7), pages 1921-1957, July.
    3. Zhao, Huan, 2011. "Four Market Studies for the Beef and Electric Power Industries," ISU General Staff Papers 201101010800001360, Iowa State University, Department of Economics.
    4. Holladay, J. Scott & Price, Michael K. & Wanamaker, Marianne, 2015. "The perverse impact of calling for energy conservation," Journal of Economic Behavior & Organization, Elsevier, vol. 110(C), pages 1-18.
    5. Severin Borenstein, 2007. "Customer Risk from Real-Time Retail Electricity Pricing: Bill Volatility and Hedgability," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2), pages 111-130.
    6. Ritz, Robert A., 2014. "Price discrimination and limits to arbitrage: An analysis of global LNG markets," Energy Economics, Elsevier, vol. 45(C), pages 324-332.
    7. Orea, L. & Steinbuks, J., 2012. "Estimating market power in homogenous product markets using a composed error model: application to the California electricity market," Cambridge Working Papers in Economics 1220, Faculty of Economics, University of Cambridge.
    8. Lazarczyk, Ewa, 2013. "Market Specific News and Its Impact on Electricity Prices – Forward Premia," Working Paper Series 953, Research Institute of Industrial Economics, revised 20 Aug 2013.
    9. Dressler, Luisa, 2016. "Support schemes for renewable electricity in the European Union: Producer strategies and competition," Energy Economics, Elsevier, vol. 60(C), pages 186-196.
    10. repec:ten:wpaper:20141 is not listed on IDEAS
    11. Chiara Lo Prete and Benjamin F. Hobbs, 2015. "Market power in power markets: an analysis of residual demand curves in Californias day-ahead energy market (1998-2000)," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    12. N. Gülpınar & F. Oliveira, 2014. "Analysis of relationship between forward and spot markets in oligopolies under demand and cost uncertainties," Computational Management Science, Springer, vol. 11(3), pages 267-283, July.
    13. Bunn, Derek W. & Oliveira, Fernando S., 2016. "Dynamic capacity planning using strategic slack valuation," European Journal of Operational Research, Elsevier, vol. 253(1), pages 40-50.
    14. Peña, Juan Ignacio & Rodriguez, Rosa, 2016. "Time-zero efficiency of European power derivatives markets," Energy Policy, Elsevier, vol. 95(C), pages 253-268.
    15. Rammerstorfer, Margarethe & Wagner, Christian, 2009. "Reforming minute reserve policy in Germany: A step towards efficient markets?," Energy Policy, Elsevier, vol. 37(9), pages 3513-3519, September.

    More about this item

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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