Pricing Forward Contracts in Power Markets by the Certainty Equivalence Principle: Explaining the Sign of the Market Risk Premium

Fred Espen Benth, Álvaro Cartea () and Ruediger Kiesel

No 611, Birkbeck Working Papers in Economics and Finance from Birkbeck, Department of Economics, Mathematics & Statistics

Abstract: In this paper we provide a framework that explains how the market risk premium, defined as the difference between forward prices and spot forecasts, depends on the risk preferences of market players. In commodities markets this premium is an important indicator of the behaviour of buyers and sellers and their views on the market spanning between short-term and long-term horizons. We show that under certain assumptions it is possible to derive explicit solutions that link levels of risk aversion and market power with market prices of risk and the market risk premium.

Keywords: Contango; backwardation; market price of risk; electricity forwards; market risk premium; forward risk premium; forward bias. (search for similar items in EconPapers)
Date: 2006-10
New Economics Papers: this item is included in nep-ene, nep-mic and nep-upt
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Citations: View citations in EconPapers (50)

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https://eprints.bbk.ac.uk/id/eprint/26932 First version, 2006 (application/pdf)

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Journal Article: Pricing forward contracts in power markets by the certainty equivalence principle: Explaining the sign of the market risk premium (2008)
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