Spot price modeling and the valuation of electricity forward contracts: The role of demand and capacity

Álvaro Cartea () and Pablo Villaplana

Journal of Banking & Finance, 2008, vol. 32, issue 12, 2502-2519

Abstract: We propose a model where wholesale electricity prices are explained by two state variables: demand and capacity. We derive analytical expressions to price forward contracts and to calculate the forward premium. We apply our model to the PJM, England and Wales, and Nord Pool markets. Our empirical findings indicate that volatility of demand is seasonal and that the market price of demand risk is also seasonal and positive, both of which exert an upward (seasonal) pressure on the price of forward contracts. We assume that both volatility of capacity and the market price of capacity risk are constant and find that, depending on the market and period under study, it could either exert an upward or downward pressure on forward prices. In all markets we find that the forward premium exhibits a seasonal pattern. During the months of high volatility of demand, forward contracts trade at a premium. During months of low volatility of demand, forwards can either trade at a relatively small premium or, even in some cases, at a discount, i.e. they exhibit a negative forward premium.

Keywords: Power; prices; Demand; Capacity; Forward; premium; Forward; bias; Market; price; of; capacity; risk; Market; price; of; demand; risk; PJM; England; and; Wales; Nord; pool (search for similar items in EconPapers)
Date: 2008
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (75)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0378-4266(08)00085-X
Full text for ScienceDirect subscribers only

Related works:
Working Paper: Spot Price Modeling and the Valuation of Electricity Forward Contracts: the Role of Demand and Capacity (2007)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:32:y:2008:i:12:p:2502-2519

Access Statistics for this article

Journal of Banking & Finance is currently edited by Ike Mathur

More articles in Journal of Banking & Finance from Elsevier
Bibliographic data for series maintained by Catherine Liu ().