Assessing the influence of spot price predictability on electricity futures hedging

Hipòlit Torró

Abstract

ABSTRACT

A common feature of energy prices is that spot price changes are partially predictable due to weather and demand seasonalities. This paper follows the Ederington and Salas framework and considers the expected change in spot prices when minimum-variance hedge ratios are computed. The poor effectiveness of hedging strategies obtained in previous studies on electricity is explained by the fact that the standard hedging approach underestimates the effectiveness of hedging. In the empirical study made in this paper, weekly spot price risk is hedged with weekly futures in the Nord Pool electricity market. In this case, the optimal selection of the futures contract may produce risk reductions whose values vary between 60% and 80% - depending on the hedging duration (one to three weeks) and the analyzed subperiod (in-sample and out-of-sample subperiods).