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Can Financial Participants Improve Price Discovery and Efficiency in Multi-Settlement Markets with Trading Costs?

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  • Akshaya Jha
  • Frank A. Wolak

Abstract

The introduction of purely financial participants into commodity markets is thought to yield forward prices that better reflect future spot prices, and ultimately, more efficient future production and consumption decisions. However, there are sizable transaction costs associated with trading in most commodity markets. This paper develops a statistical test of the null hypothesis that expected forward/spot price spreads cannot be arbitraged even after accounting for these transactions costs. We apply this test to hourly, location-specific day-ahead and real-time prices from California's wholesale electricity market. The implied trading cost required to reject the null hypothesis of no profitable arbitrage opportunities falls significantly after California allowed purely financial participation. Moreover, variable input costs per MWh of electricity produced fell by 3.6% in high demand hours after the introduction of purely financial participants. Combined, our evidence supports the hypothesis that the introduction of purely financial participants into the California wholesale electricity market decreased the average difference and the volatility of the difference between day-ahead and real-time prices, which ultimately lowered the total variable cost of serving demand

Suggested Citation

  • Akshaya Jha & Frank A. Wolak, 2019. "Can Financial Participants Improve Price Discovery and Efficiency in Multi-Settlement Markets with Trading Costs?," NBER Working Papers 25851, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:25851
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Leslie, Gordon W., 2021. "Who benefits from ratepayer-funded auctions of transmission congestion contracts? Evidence from New York," Energy Economics, Elsevier, vol. 93(C).
    2. Ehsan Samani & Mahdi Kohansal & Hamed Mohsenian-Rad, 2021. "A Data-Driven Convergence Bidding Strategy Based on Reverse Engineering of Market Participants' Performance: A Case of California ISO," Papers 2109.09238, arXiv.org.
    3. Van Moer, Geert, 2019. "Electricity market competition when forward contracts are pairwise efficient," MPRA Paper 96660, University Library of Munich, Germany.
    4. Hopkins, Caroline A., 2020. "Convergence bids and market manipulation in the California electricity market," Energy Economics, Elsevier, vol. 89(C).

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    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
    • Q02 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - General - - - Commodity Market
    • Q4 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy

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