Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets

39 Pages Posted: 17 Feb 1999

See all articles by Hendrik Bessembinder

Hendrik Bessembinder

Arizona State University; W.P. Carey School of Business

Michael L. Lemmon

University of Utah - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: January 1999

Abstract

Electricity cannot be economically stored, leading to volatile spot prices and implying that standard cost-of-carry relations are not useful for pricing electricity forward contracts. We model spot and forward power markets, evaluating the demand for risk reduction and assessing equilibrium spot and forward power prices. We obtain the implication that the forward price will contain a risk premium that depends on both the variance and the skewness of spot electricity demand. We show that power-producing firms' optimal forward market positions depend on forecast output and on the skewness of power demand. Power retailing firms' optimal forward positions depend on forecast usage, and on two statistical measures of interrelations between local and system demand that we refer to as power betas, and the coskewness of local power demand with system-wide demand. We use available data on electricity futures and spot delivery prices to provide preliminary empirical evidence that is generally consistent with our predictions.

JEL Classification: G0, D4

Suggested Citation

Bessembinder, Hendrik (Hank) and Lemmon, Michael L., Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets (January 1999). Available at SSRN: https://ssrn.com/abstract=147128 or http://dx.doi.org/10.2139/ssrn.147128

Hendrik (Hank) Bessembinder (Contact Author)

Arizona State University ( email )

PO Box 873906
Tempe, AZ 85207
United States

W.P. Carey School of Business ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

HOME PAGE: http://https://wpcarey.asu.edu/people/profile/2717225

Michael L. Lemmon

University of Utah - Department of Finance ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States
801-585-5210 (Phone)
801-581-7214 (Fax)

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