Contracts For Difference Research Articles

Variable neighbourhood search for financial derivative problem

We propose a new matching problem for combinatorial optimization in financial markets. The problem studied here has arisen from the financial regulators that collect transaction data across regulated assets classes. Unlike previous matching problems, our focus is to identify any unhedged/unmatched derivative, Contract for Difference (CFD) with its corresponding underlying asset that has been reported to the corresponding component authorities. The underlying asset and CFD transaction contain variables like volume and price. Therefore, we are looking for a combination of underlying asset variables that may hedge/match the equivalent CFD variables. Our aim is to identify unhedged /unmatched CFD?s. This problem closely relates to the goal programming problem with variable parameters. In this paper, we construct and implement a variant of BasicVariable Neighborhood Search (BVNS) with our newly constructed local search techniques that performs efficient neighbourhood search to solve these types of problems. Computational results show that the proposed approach achieve good solutions.

Forward Commodity Trading with Private Information

Firms that trade a commodity that has a random price can reduce risk by trading forward. In “Forward Commodity Trading with Private Information,” Edward J. Anderson and Andrew B. Philpott consider a setting in which a buyer and a seller of a divisible commodity have different private information on the probability distribution of its future price. This situation arises in electricity pool markets where contracts for differences are traded by buyers and sellers of electricity to hedge future price risk. The paper compares several mechanisms for settling the price and quantity of such a contract when buyers and sellers have private information. These include Nash bargaining and supply- function equilibrium models. In the latter setting, a player can deduce the other player’s private information from its offered supply function and use this to improve its own supply function. Examples are given to show that this strategy, when used by both firms, may make both firms worse off in equilibrium.

Pairs trading strategies in a cointegration framework: back-tested on CFD and optimized by profit factor

ABSTRACTStatistical arbitrage is based on pairs trading of mean-reverting returns. We used cointegration approach and ECM-DCC-GARCH to construct 98 pairs of 152 stocks of 3 currencies. Stocks trading is done by Contract for Difference (CFD), a financial derivative product which facilitates short selling and provides a leverage up to 25 times. To measure the performance of a leveraged strategy, we introduced the profit factor which is the annualized return rate per unit risk. And the historical risk is measured by maximum drawdown. We compared three main strategies: percentage, standard deviation of cointegration long-term residuals and Bollinger Bands (dynamic standard deviation), with and without double confirmation of short-term standard deviation modelled by ECM-DCC-GARCH. Each of the three main strategies is optimized by two optimizers: absolute profit and profit factor. The optimization period goes from 2012–01-01 to 2014–12-31, and validation period is from 2015–01-01 to 2016–06-01. Our results showed that the USD Bollinger Bands strategy without double confirmation and optimized by profit factor, outperformed other strategies and provided the highest annualized return rate per unit risk; 32% of our sample pairs ended up in loss, and 94% of which are explained by a cointegration break during the testing period.

Stabilization Mechanisms for Nuclear Investments vs.Electricity Market Liberalization:The Case of Contract forDifference. Lessons from theUnited Kingdom and Romania

The article addresses Contracts for Difference (CfD) as state aid and price stabilization mechanisms needed to mitigate the risks stemming from the incompat- ibility of liberalized electricity markets and nuclear energy investments. It starts by defining CfD mechan- ism as state aid required to support nuclear invest- ments. It continues by analyzing the issue of state aid in relation to the nuclear sector, with focus on the ``market failure'' argument as it transpires from both the European Commission's assessment of the state aid scheme and the decision of the Grand Chamber of the Court of Justice of the European Union. Attention is dedicated to the uses of the same support scheme in two similar nuclear projects in Hinkley Point (United Kingdom) and CernavodaÆ (Romania). The article concludes that given the systemic differences between the two national energy markets, CfD might not be a suitable solution for both national energy markets.

Effect of electricity market price uncertainty modelling on the profitability assessment of offshore wind energy through an integrated lifecycle techno-economic model

According to the Contracts for Difference (CfD) scheme introduced to support the deployment of offshore wind installations, an electricity generation party is paid the difference between a constant “strike price” (determined be means of a competitive auction) and the average UK market electricity price for every MWh of power output produced. The scheme lasts for 15 years, after which the electricity output is sold on the average market price. To this end, estimating the long term profitability of the investment greatly depends on the forecasted market prices. This paper presents the simulation results of future electricity prices based on three different simulation methods, namely: the Geometric Brownian motion (GBM), the Autoregressive Integrated Moving average (ARIMA) and a model combining Mean-Reversion and Jump-Diffusion (MRJD) processes. A number of simulation paths are generated for a time horizon of 10 years and they are introduced to a fully integrated techno-economic model developed by the authors. As a result, joint probability distributions of the NPV derived from the three different methods are presented. This study is relevant to investors and policy makers to check the viability of an investment and to predict its stochastic temporal return profile.

CFDs, forwards, futures and the cost-of-carry

We show that contracts for difference (CFDs) may be viable substitutes for forward contracts and may have some features that are preferable to futures contracts. We develop parity relations between CFDs, forwards, and futures contracts using simple cost-of-carry arguments. We use these parity relations to consider whether exchange listed stock index CFDs might be viable substitutes for exchange listed futures contracts. Using the S&P/ASX 200 stock index we find that listed CFDs (ignoring an open interest charge) generate cash flows similar to listed futures contracts. Our analysis considers stochastic interest rates and uncertain dividend payments by the shares in the index.

The Cost of Trading from the Fund Manager's Perspective

The cost of executing orders could differ from the cost of trades. We estimate the cost of a fund manager’s orders to trade in shares and contracts for differences (CFDs), using data for 2013-15. We compare directly the effective half-spread (EHS) of an order with the EHS that would be inferred using market data, namely the average EHS of trades in the relevant share, and the quoted half-spread. The typical EHS of an order is approximately same as the cost inferred from market data, while the typical cost of CFDs is slightly higher. However, there is wide variation in the cost of orders, and about one third have a negative spread. The cost of orders by value exceeds the inferred cost, mainly because of a small percentage of orders with very large spreads.

Determining commercially viable two-way and one-way ‘Contract-for-Difference’ strike prices and revenue receipts

In this article, we investigate the role that a Contract-for-Difference (CFD) might play in increasing investment in renewable energy in Australia. Two CFD schemes are investigated: two-way and one-way CFD. A financial model is developed that determines commercially viable CFD strike prices. Account is taken of revenue from wholesale electricity market and renewable energy certificate sales. Capital and operational costs of the project including distribution of funds to holders of equity and debt are also included. Findings based on analysis of the solar array located at the University of Queensland Gatton Campus in Australia is presented, employing a typical meteorological year framework. The major finding was that Government will prefer a two-way CFD scheme and Single-Axis tracking solar PV array technology. In contrast, project proponents will strongly prefer a one-way CFD design.

Opinion on the new financial products issued by financial institutions - structured products

Abstract Structured products are financial instruments issued by a financial institution where the amount claimed by the investor from the issuer depends on the variation of the price of the underlying instrument based on which the certificate is issued, namely: individual shares, share costs, stock indexes, currencies, commodities or combinations of these according to the prospectus. These products appeared with the development and diversification of financial services during the recent years, as well as due to the emergence of liquidity suppliers of international importance. The liquidity providers have developed on their own platforms a new range of derivatives which are different from the classical derivatives. These new derivatives, similar to contracts for difference (CFDs), have given to other institutions the possibility of transferring their risk more easily, regardless of the nature or type of the underlying asset. Thus, the financial institutions issuing structured financial products have found in liquidity providers the possibility of developing the CFDs required for their risk transfer operations. The issuers of structured products do not accept new risky positions when they issue certificates because they neutralize them through suitable risk transfer operations. The issuing financial institutions structure certificates from a variety of financial assets and/or commodities in order to adjust them to the various risk profiles of investors both in terms of expected return and in terms of the response to risk. Thus, products are issued that quickly respond to the trends of the financial or commodity markets. Investors in structured financial products benefit from the economic effect of a derivative but are exposed to financial risks that are more complex and more difficult to understand and at the same time depend on the reliability and stability of the contractual relationships between various financial institutions.

Investment with incomplete markets for risk: The need for long-term contracts

Barring subsidies, investment in the power generation sector has come to an almost complete halt in the restructured European power sector. Market and regulatory failures such as the well known missing money (see Joskow, (2006)) but also normal market features such as risk, possibly also affected by market failures like market incompleteness are mentioned as common causes for the situation. This paper discusses incomplete risk trading and its impact on investment. The analysis applies computable stochastic equilibrium models on a simple market model of the Energy Only type. The paper first compares the cases of complete and fully incomplete markets (full risk trading and no risk trading). It continues by testing the impact of different risk trading contracts on both welfare and investment. We successively consider Contracts for Difference, Reliability Options with and without physical back up that we add to our Energy Only market model. We test the impact of market liquidity on the results. Finally, we compare these methods to a Forward Capacity Market that we also add to the energy only model. We complete the paper by interpretation of these results in terms of hurdle rate implied by these risk-trading situations.

Hybrid renewable energy support policy in the power sector: The contracts for difference and capacity market case study

The article employs qualitative methods in contextualizing and conceptualizing the hybrid renewable energy support policy. It claims that hybrid policies may combine distinct mechanisms to drive desirable objectives better than traditional policies. A policy cycle helps to frame the United Kingdom's Contracts for Difference and Capacity Market (CFD & CM) scheme as a case study. The CFD & CM policy emerged to address environmental and energy challenges through the deployment of renewable energy (RE) in a low-carbon economy, employing liberalization: Environmental protection is foremost in this scheme. The policy combines and improves on the elements of feed-in tariff (FIT) and quota obligation (QO), and strives to solve the problems of these traditional policies. It addresses regulatory uncertainty under FIT by employing private law mechanics to guarantee above-loss reward for low carbon generation, and addresses market uncertainty under QO by incentivizing the capacity to supply future low carbon energy based on projected demand, hence creating a predictable and stable market. It also accommodates other important commitments. Overall, the CFD & CM scheme is a hybrid policy that engages the energy market mainly for advancing the end goal of environmental protection. To thrive however, it needs to meet private sector interests substantially.

Study on the Abuse of Equity OTC Derivatives Including TRS(Total Return Swap) and CFD(Contract for Difference): Focused on the Corporate Governance and Unfair Trading

Study on the Abuse of Equity OTC Derivatives Including TRS(Total Return Swap) and CFD(Contract for Difference): Focused on the Corporate Governance and Unfair Trading

Key Derivatives Cases 2015

The paper considers key derivatives cases in the English courts from 2015, namely: Wani v Royal Bank of Scotland, Dexia v Commune di Prato, Enasarco v Lehmans, SwissMarine v O.W. Supply, and MHB Bank v Shanpark.Derivative products covered include: base rate swaps, interest rate swaps, caps, collars and corridors, extendable swaps, constant proportional portfolio insurance (CPPI) funds, fund options, and contracts for difference (CFDs).ISDA 1992 and 2002 Master Agreement provisions considered include s. 2 Obligations, s. 6 Early Termination, s. 6(f) Set-off, s.13(b) Jurisdiction, s.14 Definitions of Loss and Market Quotation.Additional cases will be added in due course.

Contracts for Dummies? The Performance of Investors in Contracts for Difference

Contracts for Dummies? The Performance of Investors in Contracts for Difference

Derivatives Within Frontier Markets

The objective of this study is to develop a practical comprehensive survey of derivatives presently trading within frontier markets for use by money managers and hedgers, assessing the array of derivative types and their uses. A literature search reveals that no frontier market survey of this kind currently exists. In this study, exchange-traded and over-the-counter (OTC) derivatives include the following instruments: futures, forwards, swaps, options, and contracts for differences. The survey also includes ETFs. Where data exist, the survey provides information on the location and availability of frontier market derivative contract descriptions and price and volume data. Such information on derivatives is of increasing practical value and convenience to both investors and hedgers transacting in today’s frontier markets.

Contracts for difference: risks faced by generators under the new renewables support scheme in the UK

The Energy Act 2013 received royal assent in December 2013. It implements the Feed-in-Tariff Contracts for Difference (the CfD) which is set to become the primary support scheme for low carbon generation in the UK by 2017. The CfD will be in the form of a long-term contract between a low carbon generator and a counterparty which is a state-owned limited liability company (the CfD Counterparty). It is intended to remove long-term price risk for low carbon generators which sell electricity into the market, thereby stabilizing their revenues and reducing the cost of financing their projects. This article comments on the uncertainties currently faced by generators (or developers) of existing (or planned) electricity generation plants in the UK brought on by the implementation of the CfD regime.

Rescuing U.S. Merchant Nuclear Power: Advancing National Security, Economic, Energy, and Environmental Imperatives

U.S. merchant nuclear plants face reduced revenues and, in some cases, cash operating losses that can lead to early and permanent closure for economic reasons. A program which leverages incremental electricity pricing support through contracts for difference can avoid these needless early retirements of vital assets.

Quantifying the Effects of New Derivative Introduction on Exchange Volatility, Efficiency and Liquidity

Quantifying the Effects of New Derivative Introduction on Exchange Volatility, Efficiency and Liquidity

How Have Contracts for Difference Affected Irish Equity Market Volatility?

Contracts for Difference (CFDs) have existed for less than twenty years and the market has grown significantly up to the period before the recent international crises. This paper presents an analysis of how CFDs have affected equity market volatility in Ireland. EGARCH models are used to uncover volatility changes in the periods before and after the introduction of the new trading product in Ireland. We find that CFDs appear to have lowered asset-specific volatility across the majority of equities traded on the Irish Stock Exchange. These findings do not correspond to the expected volatility increase associated with leveraged products that are closely associated with high frequency trading. Our empirical analysis suggests that CFDs are having an alternative volatility reducing effect through the presence of bid and ask price overhangs that are generated through the hedging practices of CFD brokers. A fully worked example of the development of an overhang is provided.

Quantifying the Effects of the Inclusion and Segregation of Contracts for Difference in Australian Equity Markets

This study examines the effects that Contracts for Difference (CFDs) have had on the Australian equity market, either as an accelerant for mispricing, or as a source of increased market functionality through the addition of a new tradable product and increased liquidity. The Australian Securities Exchange (ASX) made the decision to segregate CFDs to a separate ring-fenced exchange in November 2007. This study uses EGARCH techniques to test for the effects of CFDs on return volatility at the time of CFD inclusion and segregation in Australian equity markets at the index and equity-specific level. A fully worked explanation and example of a CFD-influenced overhang is also provided. The results provide evidence that cannot reject the presence of overhangs in Australian equity markets.