Electricity Forward Prices: A High-Frequency Empirical Analysis
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Transcript of Electricity Forward Prices: A High-Frequency Empirical Analysis
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Electricity Forward Prices: A High-FrequencyEmpirical Analysis
FRANCIS A. LONGSTAFF and ASHLEY W. WANG
AUGUST 2004
Reporter: You-cheng Luo
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OutlineIntroductionDataEmpirical TestsTime Variation in Forward PremiaVolatility AnalysisConclusion
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IntroductionThese types of derivative contracts are
rapidly growing in importance as both financial risk management tools for hedgers as well as liquid investment vehicles for energy trading firms. Since electricity is not storable, the standard no-arbitrage approach to modeling forward prices cannot be applied.
Now we focus on the question of how electricity forward prices are related to expected spot prices
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PJM marketWhat’s PJM market?
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Data
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Data
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Data
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Data
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Forward PremiaThe forward premium can now be defined as
FPit = Et [Fit − Si,t+1]
Fit : the electricity forward price observed on day t for delivery during hour i of day t + 1
Si,t+1 :the spot price for hour i of day t + 1.
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Empirical Tests
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Empirical TestsBessembinder and Lemmon show that the
forward premium can be expressed in reduced form as a simple linear combination of the variance and skewness ofthe endogenous spot price
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Time Variation in Forward Premianote that the realized or ex post forward
premium can be expressed as
where represents the unexpected component of the realized forward premium and is orthogonal to information at time t
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Time Variation in Forward PremiaMost asset pricing models have in common the feature
that risk premia are directly related to measures of risk, typically expressed in terms of second moments
VSit :the conditional variance of unexpected price changes
VLit :the conditionalvolatility of unexpected changes in load
VRit :the conditional volatility of unexpected changes in revenue
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Time Variation in Forward Premia
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Time Variation in Forward Premia
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Volatility AnalysisUnder the null hypothesis that the forward
premium FPit equals zeroFit = Et [Si,t+1]
Consequently, all moments of the left-hand and right-hand sides of equation should be equal
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Volatility Analysis
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Volatility Analysis
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Conclusion1. the pricing of electricity forward contracts in the
dayahead forward market and their relation to the corresponding spot prices
2. We find that there are significant forward premia in electricity forward prices and forward premia are negatively related to price volatility and positively related to price skewness.
3. We find that each of these risk measures plays a significant role in explaining the forward premium these results demonstrate that electricity forward premia vary significantly through time.