Department of Economics and Business Economics

Risk premia in energy markets

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  • Almut E.D. Veraart, Imperial College London and Creates, United Kingdom
  • Luitgard A.M. Veraart, London School of Economics, United Kingdom
Risk premia between spot and forward prices play a key role in energy markets. This paper derives analytic expressions for such risk premia when spot prices are modelled by Lévy semistationary processes. While the relation between spot and forward prices can be derived using classical no-arbitrage arguments as long as the underlying commodities are storable, the situation changes in the case of electricity. Hence, in an empirical study based on electricity spot prices and futures from the European Energy Exchange market, we investigate the empirical behaviour of electricity risk premia from a statistical perspective. We find that a model-based prediction of the spot price has some explanatory power for the corresponding forward price, but there is a significant additional amount of variability, the risk premium, which needs to be accounted for. We demonstrate how a suitable model for electricity forward prices can be formulated and we obtain promising empirical results.
Original languageEnglish
Place of publicationAarhus
PublisherInstitut for Økonomi, Aarhus Universitet
Number of pages28
Publication statusPublished - 28 Jan 2013
SeriesCREATES Research Papers

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