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Price risk and hedging strategies in Nord Pool electricity market evidence with sector indexes

Ben Amor Souhir, Boubaker Heni and Belkacem Lotfi

Energy Economics, 2019, vol. 80, issue C, 635-655

Abstract: Electricity markets become more competitive due to their liberalization; therefore, electricity prices are considerably more volatile compared to other commodity prices. As the electricity is an integral part of production and economic growth processes, the electricity price may influence the stock market through affecting the real output and consequently the sum of cash flows. Hence, investors are facing electricity price risks, and need to protect their benefits. This paper investigates the impacts of electricity market variations on the Nordic stock market returns using hourly observations of electricity spot prices pairwise in aggregate market index and some sector indexes. Our sample is divided into three sub-periods according to the electricity volatility structure. A generalized long memory model is adopted to estimate the conditional mean of the studied time series, and the FIGARCH process is used to model the conditional variance. Thereafter, a VaR, c-DCC-FIGARCH, CVaR and ΔCVaR models are applied to assess electricity market exposure. Moreover, in order to evaluate the optimal portfolio, we calculated the optimal portfolio weights, the optimal hedge ratios and the hedge effectiveness index of the electricity market commodity in several sectors stock portfolios. Our results show evidence of long run dependence between electricity market returns and sectoral stock market returns, and they indicate that the tail dependence is significant and varies across sectors and over periods. Finally, the optimal weights and hedge ratios for electricity/stock portfolio holdings are sensitive to the considered sectors. Therefore, electricity market commodities can be adopted to diversify and hedge against stock market risks.

Keywords: Electricity market; Sector indexes; Long run dependence; Risk management; Conditional VaR-optimal hedge ratio (search for similar items in EconPapers)
Date: 2019
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Energy Economics is currently edited by R. S. J. Tol, Beng Ang, Lance Bachmeier, Perry Sadorsky, Ugur Soytas and J. P. Weyant

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