European Financial and Accounting Journal 2011, 6(1):76-103 | DOI: 10.18267/j.efaj.40

Portfolio Theory and Electricity Forward Markets

Michal Michalovský1, Igor Paholok2
1 Bc. Michal Michalovský - graduate student; Faculty of Finance and Accounting, University of Economics Prague, W. Churchill sq. 4, 130 67 Prague 3, Czech Republic; <michalovsky@institutee.cz>.
2 Ing. Igor Paholok - Ph.D. student; Department of Banking and Insurance, Faculty of Finance and Accounting, University of Economics Prague, W. Churchill sq. 4, 130 67 Prague 3, Czech Republic; <paholok@institutee.cz>.

In the discussion on the relationship between spot and forward prices in electricity markets, the equilibrium approach has an unambiguous prevalence. It is the relative recency of this market that gives rise to the question of how precisely forward prices converge to the spot prices. We decide to measure this convergence, with its eventual imbalance called risk premium, on several European energy exchanges trading electricity futures. The concept of risk premium, as it is worked out by Bessembinder and Lemon (2002) is reviewed in our essay through the Markowitz portfolio theory. Unlike in the B-L model, where the variance of the spot price has a strictly negative relationship to the risk premium, it is shown that the portfolio theory gives us a different inference that the variance can have both negative and positive impacts according to the strength of supply and demand in the market. This empirically tested and found appropriate. Positive dependence of variance in the electricity markets have been found in Central Europe and Scandinavia, while in Iberian the results are still negative.

Keywords: B-L equilibrium model, Electricity forward markets, Portfolio theory
JEL classification: G14, L11, Q41

Published: March 1, 2011  Show citation

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Michalovský, M., & Paholok, I. (2011). Portfolio Theory and Electricity Forward Markets. European Financial and Accounting Journal, 6(1), 76-103. doi: 10.18267/j.efaj.40
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