Forward Prices Research Articles

Policy Uncertainty about Australia's Carbon Price: Expert Survey Results and Implications for Investment

AbstractAustralia's carbon‐pricing policy remains in doubt due to a lack of bipartisan political support. A survey of Australian‐based carbon‐pricing experts demonstrates profound policy uncertainty: 40 per cent of respondents expect the current carbon‐pricing mechanism to be repealed, but 80 per cent expect that there will be a carbon price in 2020. The forward price curve is U‐shaped and has great variance, with the 60 per cent confidence interval spanning from zero to A$25/t in 2020. Carbon policy uncertainty causes large excess costs in Australia's energy sector and may result in delay and diversion of investment.

Price determination in the EU ETS market: Theory and econometric analysis with market fundamentals

We investigate the price determination of the European Union emission allowance (EUA) of the European Union emissions trading scheme (EU ETS). We postulate an uncertain permit price and risk-averse firms which have the possibility to hedge in the forward market. The firms produce final goods, abate their emissions and trade permits in the permit market. The dependence of the equilibrium permit price on exogenous variables is studied in a permit market model. We test our theoretical findings with empirical data from 2005 to 2010 in the EU ETS market. We use daily forward prices of EUA as our dependent variable. We use several econometric models with multiple stationary time series to discover that there is a strong relationship between the fundamentals, such as German electricity prices and gas and coal prices, with the price of EUA. We find that the EUA forward price depends on fundamentals, especially on the price of electricity as well as on the gas–coal difference, in a statistically significant way.

Analysis of the Dynamics of the Brazilian Forward Market of Electricity

Between 1996 and 2003, several countries, including Brazil, began to restructure their electricity sectors and established free markets for energy trading. The growth of these markets has required the adaptation of financial instruments for risk management and return to the particulars of each market. In Brazil, the market still has a disorganized and decentralized over-the-counter market (OTC) structure, which is more difficult to analyze due to the lack of public information. In this setting, the bilaterally negotiated forward contracts for electricity are the primary instruments to mitigate risks and evaluate investments. In this context, the objective of this study is to better understand the dynamics of the forward price of electricity negotiated in Brazil. In this article, we propose a method to construct the forward curve based only on market information and show an application of this approach. Our results indicate that the Brazilian forward market of electricity has a contango behaviour in certain periods, high risk premiums and only partial adherence of forward prices to the expectations of future spot prices. Studies support these evidences. Key words: Electricity trading. Foward market. Risk premium.

An Analysis of the Main Determinants of Electricity Forward Prices and Forward Risk Premia

The liberalisation of energy markets entails the appearance of market risks which must be borne by market participants: producers, retailers and final consumers. Some of these risks can be managed by participating in the forward markets and transferring it to other agents who are willing to bear it and command a compensation for it. Thus, forward prices are made up of two components: the expected spot price at a future date and the forward risk premium. In this chapter we analyse the factors influencing the evolution of electricity forward prices in Spain. These factors include the forward prices for natural gas and CO2 emission rights, as well as the electricity forward prices in Germany and in France and spot prices in Spain. We also analyse the behaviour of the ex-post electricity forward risk premia in Germany, France and Spain, and in particular we find a positive correlation between ex-post electricity risk premia in these three countries as well as between risk premia for electricity and natural gas futures prices.

A Solution to the Palm — 3Com Spin-Off Puzzles

This paper revisits the relative pricing of Palm and 3Com shares in 2000. We offer a simple rational explanation of the Palm/3Com price relationship before Palm’s spinoff is completed. Lending fees and spin-off uncertainty are crucially important to understanding the relative levels and co-movement of Palm and 3Com share prices. We use Palm’s post-spinoff forward prices (calculated from the market prices of calls and puts) and model the spin-off uncertainty in valuing 3Com. Considering forward pricing and spin-off uncertainty resolves various pricing puzzles and explains the observed empirical evidence, including a sharp change in relative price behavior once the spinoff uncertainty is resolved on May 8, 2000.

Market efficiency and risk premia in short-term forward prices

Using recursive estimation and rolling windows over extended sample periods we examine the time-varying relationship between spot and short-term forward prices in the Pennsylvania–New Jersey–Maryland (PJM) wholesale electricity market. We examine theoretical models of forward risk premia in electricity markets and show that recent data do not provide support for existing models. The results indicate that short-term forward prices have converged towards unbiased predictors of the subsequent spot prices.

Credit Risk, Liquidity and Cost of Capital: Foreign-Exchange Forwards in a Post-2008 World

Covered interest rate parity allows one to price foreign exchange forwards using no-arbitrage arguments, such that given the rate of risk-free return in both currencies, the forward discount/premium can be determined precisely. This largely held true until mid 2007, when the U.S. sub-prime crisis and subsequent global financial crisis led to U.S. dollar funding constraints that significantly impacted forward prices. We find that factors related to credit risk, funding costs and liquidity influence the forward exchange rate of AUD/USD, EUR/USD and GBP/USD in the post-Lehman period from July 2009 to June 2012, for tenors of 1, 2, 3, 6 months and 1 year.

Forecasting spot price volatility using the short-term forward curve

We use high frequency real time spot prices and day-ahead forward prices from the Pennsylvania–New Jersey–Maryland wholesale electricity market to calculate, describe, and forecast spot price volatility. We introduce the concept of forward realized volatility calculated from day-ahead forward prices. Forward realized volatility improves forecasts of spot price volatility – in the sense of higher R2s and significantly lower forecast errors – when compared with forecasts based solely upon historical volatility. The largest forecast improvements obtained when the change in forward realized volatility is large in magnitude. Splitting total volatility into its continuous and jump components is crucial for forecasting volatility at weekly and monthly horizons.

Forecasting Spot Price Volatility Using the Short-Term Forward Curve

This paper uses high-frequency real-time spot prices and day-ahead forward prices from the eastern hub of the Pennsylvania-New Jersey-Maryland (PJM) electricity market to calculate, describe, and forecast realized spot price volatility. Using Heterogeneous Autoregressive models of realized volatility (HAR-RV) we find that, as in financial markets, electricity volatility is persistent. We extend the literature by incorporating volatility implied by day-ahead forward prices (forward implied volatility) into our forecasts of future spot price volatility. Including forward implied volatility improves forecasts of spot price volatility - in the sense of higher R-squareds and lower forecast errors.

Forward-neutral valuation relationships for options on zero coupon bonds

This paper extends the literature on Risk-Neutral Valuation Relationships (RNVRs) to derive valuation formulae for options on zero coupon bonds when interest rates are stochastic. We develop Forward-Neutral Valuation Relationships (FNVRs) for the transformed-bounded random walk class. Our transformed-bounded random walk family of forward bond price processes implies that (i) the prices of the zero coupon bonds are bounded below at zero and above at one, and (ii) negative continuously compounded interest rates are ruled out. FNVRs are frameworks for option pricing, where the forward prices of the options are martingales independent of the market prices of risk. We illustrate the generality and flexibility of our approach with models that yield several new closed-form solutions for call and put options on discount bonds.

DERIVATIVES ON NONSTORABLE RENEWABLE RESOURCES: FISH FUTURES AND OPTIONS, NOT SO FISHY AFTER ALL

Abstract We study forwards and European call options, which are written on a nonstorable renewable resource. Examples of such derivatives in form of futures on fresh catch of wild salmon for the United States and the recently created Fish Pool market in Norway, where futures on a composite of wild catch and farmed salmon are traded, will be discussed. We approach the problem of pricing these contracts from first principles, starting off by modeling the dynamics of the resource reserves, and assuming that in approximation resource extraction is managed as open access. We derive formulas for the forward price of the renewable resource as well as European call options written on it.

Optimal Portfolio Choices, House Risk Hedging and the Pricing of Forward House Transactions

This paper develops a utility indifference model for evaluating various prices associated with forward transactions in the housing market, based on the equivalent principle of expected wealth utility derived from the forward and spot real estate markets. Our model results show that forward transactions in the housing market are probably not due to house sellers’ and buyers’ heterogeneity, but to their demand for hedging against house price risk. When the imperfections of real estate markets and the risk preferences of market participants are taken into consideration, we are able to show that the idiosyncratic risk premium, which mainly depends on the participants’ risk preferences and the correlation between the traded asset and the real estate, is a remarkable determinant of house sellers’ and buyers’ forward reservation prices. In addition, we also find that the market clearing forward price usually will not converge toward the expected risk-neutral forward price. The sellers’ or buyers’ risk aversion degrees and market powers are also identified to play crucial roles in determining the clearing forward price..

ARBITRAGE‐FREE MULTIFACTOR TERM STRUCTURE MODELS: A THEORY BASED ON STOCHASTIC CONTROL

We present an alternative approach to the pricing of bonds and bond derivatives in a multivariate factor model for the term structure of interest rates that is based on the solution of an optimal stochastic control problem. It can also be seen as an alternative to the classical approach of computing forward prices by forward measures and as such can be extended to other situations where traditionally a change of measure is involved based on a change of numeraire. We finally provide explicit formulas for the computation of bond options in a bivariate linear‐quadratic factor model.

THE AFFINE LIBOR MODELS

We provide a general and flexible approach to LIBOR modeling based on the class of affine factor processes. Our approach respects the basic economic requirement that LIBOR rates are nonnegative, and the basic requirement from mathematical finance that LIBOR rates are analytically tractable martingales with respect to their own forward measure. Additionally, and most importantly, our approach also leads to analytically tractable expressions of multi‐LIBOR payoffs. This approach unifies therefore the advantages of well‐known forward price models with those of classical LIBOR rate models. Several examples are added and prototypical volatility smiles are shown. We believe that the CIR process‐based LIBOR model might be of particular interest for applications, since closed form valuation formulas for caps and swaptions are derived.

On the relationship between forward prices of crude oil and domestic fuel: A panel data cointegration approach

<titre>R&#233;sum&#233;</titre>L&#8217;objectif de ce papier est d&#8217;&#233;tudier l&#8217;existence d&#8217;une relation de long terme entre les prix &#224; terme du p&#233;trole et du fioul domestique (FOD) sur la p&#233;riode allant d&#8217;Ao&#251;t 2003 &#224; Avril 2010. Pour cela, nous adoptons une approche en panel en consid&#233;rant les prix &#224; terme de 36 maturit&#233;s diff&#233;rentes. Les r&#233;sultats provenant des tests de coint&#233;gration en panel montrent l&#8217;existence d&#8217;une relation d&#8217;&#233;quilibre de long terme homog&#232;ne selon les maturit&#233;s entre les prix du p&#233;trole et du FOD. L&#8217;estimation d&#8217;un mod&#232;le &#224; correction d&#8217;erreur en panel a par ailleurs mis en &#233;vidence que les prix du FOD &#233;taient influenc&#233;s par ceux du p&#233;trole &#224; court comme &#224; long terme. L&#8217;existence d&#8217;un mod&#232;le d&#8217;&#233;quilibre homog&#232;ne selon les maturit&#233;s peut avoir des implications fortes dans les strat&#233;gies d&#8217;arbitrage financier, les plans de production industrielle et le calcul de prix &#224; la consommation pour les entreprises du secteur &#233;nerg&#233;tique.Classification JEL&#160;: C23&#160;; Q40.

Electricity Futures Prices: Indirect Storability, Expectations, and Risk Premiums

The goal of this paper is to examine to what extent electricity futures prices contain expected risk premiums or have power to forecast spot prices and whether this might be dependent on the type of electricity supply. We analyse futures prices from the Dutch market, a market in which power is produced with storable fossil fuels, and futures prices from the NordPool market, where electricity is mostly produced by hydropower. We show that futures prices from markets in which electricity is predominantly produced by imperfectly storable fuels such as hydro, wind and solar contain information about expected changes in the spot price of electricity, whereas futures prices from markets in which electricity is predominantly produced with perfectly storable fuels contain information about both expected price changes and time-varying risk premiums. These findings provide insight in the applicability of forward price models; one cannot apply the same model to all electricity markets. Forward models for markets with imperfect indirect storability should depend heavily on price expectations and models should include time-varying risk premiums for markets with perfect indirect storability.

The Application of the Combinatorial and Optimal Networks on the Prediction of the Consumer Price Index

Consumer price index (CPI) was a main scientific ground for manager to put forward price policy, wage policy, and national economy development strategy. A lot of study and prediction were carried out for CPI by many scientists, and corresponding achievement was obtained. However, the simple network was applied to the past perdition methods, and the prediction results was not good. The prediction method based on the combinatorial and optimal networks of BP network, Elman network, RBF network and GRNN network was established and applied to the prediction of consumer price index. The simulation results showed that the effect of the combinatorial and optimal method was better than that of single method.

Effects of skewness and kurtosis on production and hedging decisions: a skewed t distribution approach

This paper assumes that the spot price follows a skewed Student t distribution to analyze the effects of skewness and kurtosis on production and hedging decisions for a competitive firm. Under a negative exponential utility function, the firm will not over-hedge (under-hedge) when the spot price is positively (negatively) skewed. The extent of under-hedge (over-hedge) decreases as the forward price increases. Compared with the mean-variance hedger, the producer will hedge more (less) when negative (positive) skewness prevails. In addition, an increase in the skewness reduces the demand for hedging. The effect of the kurtosis, however, depends on the sign of the skewness. When the spot price is positively (negatively) skewed, an increase in kurtosis leads to a smaller (larger) futures position.

An Economic Welfare Preserving Framework for Spot Pricing and Hedging of Spectrum Rights for Cognitive Radio

In a Cognitive Radio (CR) enabled network, Secondary Users (SUs) have an impact on the Quality-of-Service (QoS), and ultimately the revenue of the PU Primary User (PU) license holders. An important metric of an investor's economic welfare is the ratio of mean returns to the volatility of returns (Sharpe ratio). Numerous CR access schemes have been proposed that fail to account for the economic welfare of PUs when SUs access their spectrum. In this paper we consider the PU's spectrum license as an investment and analyze the impact of CR activity on the PU's economic welfare, in order to derive a cost of production of spectrum access rights such that the PU's economic welfare is not degraded. This creates an incentive for PUs to permit CR access in their spectrum bands, by ensuring that the characteristics of returns on the substantial investment made in spectrum licenses are preserved. However, under any instantaneous or spot pricing scheme, the risk of price volatility is introduced. We also propose a framework to alleviate the risk to SUs from a volatile CR rights spot price, by introducing the concept of forward pricing and hedging of CR rights. This reduces the variability of cash-flow associated with the purchase of CR rights, ensuring that the QoS provided by an SU network remains unaffected by a high CR access price. We also illustrate the leverage effect, where a PU will achieve a higher mean return- on-investment with SU operation, albeit with a higher variance of returns.

Price and volatility dynamics between electricity and fuel costs: Some evidence for Spain

The purpose of this study is to investigate the causal linkages between the Spanish electricity, Brent crude oil and Zeebrugge (Belgium) natural gas 1-month-ahead forward prices. Following Lütkepohl et al. (2004), we control for the presence of a structural change in the series and then we use the Johansen cointegration test and a vector error correction model (VECM) to embrace the analysis. Additionally, a multivariate generalized autoregressive conditional heteroskedastic (GARCH) model is applied to explore volatility interactions between the three markets involved in the study. Our findings reveal that Brent crude oil and Zeebrugge natural gas forward prices play a prominent role in the Spanish electricity price formation process. Furthermore, causation, both in price and volatility, runs from Brent crude oil and natural gas forward markets to the Spanish electricity forward market. These results are of practical importance for both the wholesale and retail markets' participants as well as the regulator through the established link between the forward contracts' price and the Spanish tariff of last resort paid by more than 23million of customers.