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Modeling Term Structure Dynamics in the Nordic Electricity Swap Market

Author

Listed:
  • Dennis Frestad
  • Fred Espen Benth
  • Steen Koekebakker

Abstract

We analyze the daily returns of Nordic electricity swaps and identify significant risk premia in the short end of the market. On average, long positions in this part of the swap market yield negative returns. The daily returns are distinctively non-normal in terms of tail-fatness, but we find little evidence of asymmetry. We investigate if the flexible four-parameter class of normal inverse Gaussian (NIG) distributions can capture the observed stylized facts and find that this class of distributions offers a remarkably improved fit relative to the normal distribution. We also compare the fit with that of the four-parameter class of stable distributions; the NIG law outperforms the stable law in the vast majority of cases. Thus, the NIG family of distributions, which allows for stochastic dynamics in terms of LŽvy processes that are suitable for pricing derivatives and Value-at-Risk measurements, is a serious candidate for modeling term structure dynamics in the Nordic electricity market.

Suggested Citation

  • Dennis Frestad & Fred Espen Benth & Steen Koekebakker, 2010. "Modeling Term Structure Dynamics in the Nordic Electricity Swap Market," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2), pages 53-86.
    • Handle: RePEc:aen:journl:2010v31-02-a03
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    Citations

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    Cited by:

    1. Fleten, Stein-Erik & Hagen, Liv Aune & Nygård, Maria Tandberg & Smith-Sivertsen, Ragnhild & Sollie, Johan M., 2015. "The overnight risk premium in electricity forward contracts," Energy Economics, Elsevier, vol. 49(C), pages 293-300.
    2. Sherzod N. Tashpulatov, 2022. "Modeling Electricity Price Dynamics Using Flexible Distributions," Mathematics, MDPI, vol. 10(10), pages 1-15, May.
    3. Caldana, Ruggero & Fusai, Gianluca & Roncoroni, Andrea, 2017. "Electricity forward curves with thin granularity: Theory and empirical evidence in the hourly EPEXspot market," European Journal of Operational Research, Elsevier, vol. 261(2), pages 715-734.
    4. Deschatre, Thomas & Féron, Olivier & Gruet, Pierre, 2021. "A survey of electricity spot and futures price models for risk management applications," Energy Economics, Elsevier, vol. 102(C).
    5. Saralees Nadarajah & Bo Zhang & Stephen Chan, 2014. "Estimation methods for expected shortfall," Quantitative Finance, Taylor & Francis Journals, vol. 14(2), pages 271-291, February.
    6. Fred Benth & Jukka Lempa, 2014. "Optimal portfolios in commodity futures markets," Finance and Stochastics, Springer, vol. 18(2), pages 407-430, April.
    7. Thomas Deschatre & Olivier F'eron & Pierre Gruet, 2021. "A survey of electricity spot and futures price models for risk management applications," Papers 2103.16918, arXiv.org, revised Jul 2021.
    8. Benth, Fred Espen & Paraschiv, Florentina, 2016. "A Structural Model for Electricity Forward Prices," Working Papers on Finance 1611, University of St. Gallen, School of Finance.
    9. Fred Espen Benth & Paul Kruhner, 2014. "Derivatives pricing in energy markets: an infinite dimensional approach," Papers 1412.7943, arXiv.org.
    10. Angelica Gianfreda & Derek Bunn, 2018. "A Stochastic Latent Moment Model for Electricity Price Formation," BEMPS - Bozen Economics & Management Paper Series BEMPS46, Faculty of Economics and Management at the Free University of Bozen.
    11. Ren'e Aid & Luciano Campi & Delphine Lautier, 2015. "On the spot-futures no-arbitrage relations in commodity markets," Papers 1501.00273, arXiv.org, revised Feb 2018.
    12. Debbie Dupuis, Geneviève Gauthier, and Fréderic Godin, 2016. "Short-term Hedging for an Electricity Retailer," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    13. Fred Espen Benth & Paul Kruhner, 2014. "Representation of infinite dimensional forward price models in commodity markets," Papers 1403.4111, arXiv.org.
    14. Iván Blanco, Juan Ignacio Peña, and Rosa Rodriguez, 2018. "Modelling Electricity Swaps with Stochastic Forward Premium Models," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    15. Benth, Fred Espen & Paraschiv, Florentina, 2018. "A space-time random field model for electricity forward prices," Journal of Banking & Finance, Elsevier, vol. 95(C), pages 203-216.

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    JEL classification:

    • F0 - International Economics - - General

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