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The hedging performance of electricity futures on the Nordic power exchange

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Abstract:

The Nordic Power Exchange (Nord Pool), the first multinational exchange for electricity trading, has existed since January 1996. Spot and futures contracts are traded on this exchange and its typical characteristics are very high volatilities as well as non-normally distributed returns. This article looks at electricity futures and how they can be used for short-term hedging of positions taken in the spot market. It studies the minimum variance hedge ratio and how it can be estimated in different ways. The traditional naive hedge and the OLS hedge are compared out-of-sample to more elaborate moving average and GARCH hedges, and the empirical results indicate some gains from hedging with futures despite the lack of straight-forward arbitrage possibilities in the electricity market. Furthermore, we find a slightly better performance of the simple OLS hedge compared to the conditional hedges.

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036840210138365

Affiliations: Department of Economics, Lund University, P.O. Box 7082, S-220 07 Lund, Sweden E-mail: hans.bystrom@nek.lu.se

Publication date: January 1, 2003

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