Market making and electricity price formation in Japan

Takashi Kanamura and Derek W. Bunn

Energy Economics, 2022, vol. 107, issue C

Abstract: Market-making, a common trading practice, is often directed by regulators to improve the liquidity in new products, to make their prices more reliable as markers and to encourage new entrants. Establishing its effectiveness is sometimes elusive, however, as market participation and behaviour can be confounded by many special circumstances, especially in energy. We develop an unusual model-based approach in order to establish if a market-making intervention improved the fundamental price formation dynamics. In the context of the Japanese wholesale electricity auction, we develop a dynamic regime switching formulation to account for the distinct effects of buy-side and sell-side volumes on price formation, using temperature as a regime switching driver. The model has a nonlinear functionality that allows it to fit the spiky time series very effectively. The result is clarity that after a market-making intervention in 2017, the buy and sell volumes had more intuitive and distinct effects upon price formation, compared to previously. In addition, temperature information has been more coherently embedded in price and volatility fundamental modelling since the intervention. We argue that the model indicated a more balanced market with buy and sell side regime drivers behaving more consistently with improved market efficiency.

Keywords: Market-makers; JEPX; Liquidity; Regime switching (search for similar items in EconPapers)
JEL-codes: C51 L94 Q41 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:107:y:2022:i:c:s0140988321006071

DOI: 10.1016/j.eneco.2021.105765

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