Risk premia in electricity spot markets – New empirical evidence for Germany and Austria

Mr Niyaz  Valitov, University of Wuppertal, Germany

The process of liberalization in Europe and the growth of electricity from renewable energy sources led to a significant increase in trading activities on wholesale markets. Due to the fact that electricity cannot be economically stored and that forecasts of spot prices are often inaccurate, risk management plays an important role in forward markets. A risk premium in electricity markets, defined as the difference between the forward price and the expected spot price, is often paid as a compensation for bearing price and/or demand risks. According to Bessembinder and Lemmon (2002), the risk premium is negatively related to the variance of spot prices as well as positively related to the skewness of spot prices. Furthermore, it tends to be higher if expected demand increases. There are empirical evidences showing that power traders behave like risk-averse rational economic agents (Longstaff and Wang, 2004; Viehmann, 2011).

This paper provides new empirical evidence for risk premia in the German/Austrian day-ahead market by using data from October 2008 to November 2015. It contributes to the literature by investigating the impact of the introduction of negative electricity prices on the risk premium in forward markets. Furthermore, the relatively long observation period allows for testing the long-term stability of model parameters.

Following Viehmann (2011), risk premia are estimated by comparing hourly electricity prices of the European Power Exchange (EPEX) and of the Energy Exchange Austria (EXAA). The consistency of the model from Bessembinder and Lemmon (2002) is tested with cross-sectional regressions of the risk premium on the variance and skewness of the spot prices. In order to assess the validity of the unbiased forward rate hypothesis, daily forward prices are regressed on subsequent spot prices. Both models are estimated by applying rolling and recursive regressions with a window of 365 days.

The results suggest that risk premia are still paid in the German/Austrian day-ahead market, but their absolute value decreased remarkably. Negative electricity prices have a strong impact on the outcome and an upward bias in hours with negative prices can be observed. This result contradicts the theoretical considerations of Viehmann (2011) who expected larger negative premia. It can also be shown that the existence and development of risk premia cannot be explained by price risks alone as proposed by Bessembinder and Lemmon (2002). Results of rolling regressions indicate highly unstable parameters for the variance and skewness of spot prices. There is also some evidence that the market has matured: Forward prices tend to converge to unbiased predictors of subsequent spot prices.

References

Bessembinder, H., Lemmon, M.L., 2002. Equilibrium pricing and optimal hedging in electricity forward markets. Journal of Finance 57, 1347-1382.

Longstaff, F.A., Wang, A.W., 2004. Electricity Forward Prices: A High-Frequency Empirical Analysis. Journal of Finance 59 (4), 1877-1900.

Viehmann, J., 2011. Risk premiums in the German day-ahead Electricity Market. Energy Policy 39, 386-394.

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