Locational Price Spreads and the Pricing of Contracts for Difference: Evidence from the Nordic Market

Professorship/Faculty: Banking and Financial Control  
Author(s): Marckhoff, Jan; Wimschulte, Jens
Title of the Journal: Energy Economics
Publisher Information: Amsterdam : Elsevier
Year of publication: 2009
Volume: 31
Issue: 2
Pages: 257-268
Illustrations: Diagramme
Year of first publication: 2009
Language(s): English
DOI: 10.1016/j.eneco.2008.10.003
URL: http://www.sciencedirect.com/science/article/pi...
In electricity markets, not only does the risk of substantial price variations over time exist, but so does the risk of price variations over space, as prices between locations can differ due to transmission congestion. To manage this risk, Contracts for Difference (CfDs), i.e., forwards on the spread between a particular area price and the (unconstrained) system price, were introduced at the Scandinavian electricity exchange Nord Pool at the end of 2000. We empirically investigate the pricing of these CfDs over the period 2001 through 2006 and find that CfD prices contain significant risk premia. Their sign and magnitude, however, differ substantially between areas and delivery periods, because areas are subject to transmission congestion to a varying extent. While the relation between risk premia and time-to-maturity is not uniform for CfDs, there is a negative relation for implied area and system forwards, which can be explained by the relative hedging demand of market participants. In addition, we find that risk premia of CfDs and implied area forwards vary systematically with the variance and skewness of the underlying spot prices. This confirms both implications of the Bessembinder and Lemmon [Bessembinder, H., Lemmon, M.L., 2002. Equilibrium pricing and optimal hedging in electricity forward markets. Journal of Finance, 57, 1347–1382] model.
Keywords: Electricity, Contract for Difference, Implied area forward, Risk premium
Document Type: Article
URI: https://fis.uni-bamberg.de/handle/uniba/516
metadata.ubg.intern.opusdatepublished: 15. November 2012