Portfolio Theory and Electricity Forward Markets

Michal Michalovský and Igor Paholok

European Financial and Accounting Journal, 2011, vol. 2011, issue 1, 76-103

Abstract: In the discussion on the relationship between spot and forward prices in electricity markets, the equilibrium approach has an unambiguous prevalence. It is the relative recency of this market that gives rise to the question of how precisely forward prices converge to the spot prices. We decide to measure this convergence, with its eventual imbalance called risk premium, on several European energy exchanges trading electricity futures. The concept of risk premium, as it is worked out by Bessembinder and Lemon (2002) is reviewed in our essay through the Markowitz portfolio theory. Unlike in the B-L model, where the variance of the spot price has a strictly negative relationship to the risk premium, it is shown that the portfolio theory gives us a different inference that the variance can have both negative and positive impacts according to the strength of supply and demand in the market. This empirically tested and found appropriate. Positive dependence of variance in the electricity markets have been found in Central Europe and Scandinavia, while in Iberian the results are still negative.

Keywords: B-L equilibrium model; Electricity forward markets; Portfolio theory (search for similar items in EconPapers)
JEL-codes: G14 L11 Q41 (search for similar items in EconPapers)
Date: 2011
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DOI: 10.18267/j.efaj.40

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