Determinants of the premium in forward contracts

Whilst the benefits of forward contracting for goods and services have been extensively researched in terms of mitigating market power effects in spot markets, we analyse how the risk in spot price formation induces a counteracting premium in the contract prices. We consider and test a wide-ranging...

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Bibliographic Details
Published in:Journal of regulatory economics 2013, Vol.43 (1), p.90-111
Main Authors: Redl, Christian, Bunn, Derek W.
Format: Article
Language:English
Subjects:
Commodities
Economic models
Economic statistics
Economic theory
Economics
Economics and Finance
Electric rates
Electricity
Energy economics
Equilibrium
Europe
Forward exchange contracts
Futures market
Hedging
Industrial Organization
Investments
Market power
Market prices
Microeconomics
Original Article
Power marketers
Price uncertainty
Prices
Public Finance
Regulation
Risk
Spillovers
Studies
Wholesale prices
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Summary:Whilst the benefits of forward contracting for goods and services have been extensively researched in terms of mitigating market power effects in spot markets, we analyse how the risk in spot price formation induces a counteracting premium in the contract prices. We consider and test a wide-ranging set of propositions, involving fundamental, behavioural, dynamic, market conduct and shock components, on a long data set from the most liquid of European electricity forward markets, the EEX. We show that part of what is conventionally regarded as the market price of risk in electricity is actually that of its underlying fuel commodity, gas; that market power has a double effect on prices, insofar as it increases spot prices and induces a forward premium; that oil price sentiment spills over and that the premium reacts to scarcity and the higher moments of spot price uncertainty. We observe that considerations of the scale and determinants of the forward premium are at least as important as the market power effects in spot market price formation when evaluating the efficiency of wholesale power trading.
ISSN:0922-680X
1573-0468
DOI:10.1007/s11149-012-9202-7