Spot Price Level Research Articles

Destabilizing role of futures markets on North American hard red spring wheat spot prices

AbstractThe objective of the paper is to determine if the futures prices of hard red spring wheat (HRSW) have stabilizing or destabilizing impact on spot HRSW price in North America. Several important results emerge from thorough empirical analysis. First, both Granger causality tests and directed acyclic graph algorithms (DAGs) point to two‐way causality between futures and spot HRSW prices and thus endogeneity in both prices formation. To the contrary, both procedures suggest that ending stocks are exogenous to spot and futures HRSW prices. Both vector error correction model and impulse response functions point to a large and long‐lasting impact of a shock to futures price on spot price level. Finally, variance decomposition analysis indicates that futures prices are responsible for the bulk of spot price volatility in both short and long run. Our result is consistent with those of theoretical models suggesting that when production (supply side) is the dominant disturbance, spot price is destabilized in both the short and the long run by futures prices. An important implication of this research is the need for alternative market mechanisms or alternative farm policy measures that would mitigate price risk and ensure sustainable farming of American HRSW farmers.

The Financialization of Storable Commodities

I solve a dynamic equilibrium model of commodity spot and futures prices, incorporating an active futures market, heterogeneous risk-averse participants, and storage. When calibrated to data from the crude oil market, the model implies that financialization reduces the futures risk premium and increases correlation between futures open interest and the spot price level. However, there is no long-run increase in the mean spot price, and speculative storage generally attenuates financialization’s effect on spot price volatility. Therefore, financialization’s effect on spot price dynamics through storage arbitrage is likely modest, even if futures positions and risk premia are substantially altered.This paper was accepted by Gustavo Manso, finance.

Towards Definition of the Risk Premium Function

Successful trading in electricity markets relies on the market actor's ability to accurately forecast the electricity price. The fundamental electricity price models use market information, provided by various price drivers, including the residual that contains a risk premium. In the past, researchers investigating risk premium focused primarily on daily spot price levels, ignoring the intraday information hindering the accurate risk premium determination. This paper presents a new KGB Method for modelling of risk premium, based on “ex-ante” approach focused on a yearly product. The method involves a novel KGB Model and its linearized formulation, the KGB Linear Model, which enables capturing the influence of renewable energy sources on risk premium. The four key drivers of the KGB Linear Model were used providing an insight into the influence of RES generation on risk premium evolution. The method was tested on historical data from the German electricity market. The results for the 2010–2014 period reveal overall influence of PV production share on risk premium is greater than that of wind production share, both increasing the risk premium due to their variability and uncertainty. Using the KGB Method, market actors can forecast risk premium using information readily available to them.

On the Impact of Wind Feed-in and Interconnections on Electricity Price in Germany

In this paper, we explore carry out an empirical analysis for Germany, as a country with high penetration of wind energy, to investigate the interaction between the well-known merit-order effect, i.e., falling spot price levels as well as highly fluctuating spot prices and the European electricity grids inteconnections,i.e., market coupling.Our main empirical findings suggest that wind power in-feed decreases electricity spot price level but increases spot prices volatility. Furthermore, the relationship between wind power and spot electricity prices can be strongly impacted by European electricity grids interconnection which behaves like a safety valve lowering volatility and limiting the price decrease. Therefore, the impacts of wind generated electricity on electricity spot markets areless clearly pronounced in interconnected systems

Carbon emission permit price volatility reduction through financial options

We develop a stylized model to investigate the impact of financial options on reducing carbon permit price volatility under a cap-and-trade system. The existence of an option market provides a mechanism to hedge the uncertainty of future spot prices and is a stimulus for investment in carbon emission abatement technologies. We show that both the spot price level and the price volatility of carbon permits can be reduced via the trading of financial options, while achieving the emission reduction target. We also show that introducing financial options in a banking environment offers more flexibility to risk management in carbon permit trading.

The Financialization of Storable Commodities

I construct a dynamic equilibrium model of storable commodities populated by producers, dealers, and households. When financial innovation allows households to trade in futures markets, they choose a long position that leads to lower equilibrium excess returns on futures, a more frequently upward-sloping futures curve, and higher volatility in futures and spot markets. The effect on spot price levels is modest, and extremely high spot prices only occur in conjunction with low inventories and poor productivity. Therefore such financialization'' of commodities may explain several recently observed changes in spot and futures market dynamics, but it cannot directly account for a large increase in spot prices.

Risk Premiums in Interconnected Australian Electricity Futures Markets

We provide an empirical analysis of the relationship between spot and futures prices in interconnected regional Australian electricity markets. Examining ex-post risk premiums in futures markets, we find positive and significant risk premiums for several of the considered regions. Therefore, electricity futures prices cannot be considered as an unbiased estimator of the average realized spot price during the delivery period. Market participants are willing to pay a significant additional compensation to get rid of the exposure to price shocks and spikes in the spot market. We further demonstrate seasonal effects in the observed premiums as well as strong and positive correlations between the observed risk premiums across the considered markets. Overall, the observed premiums indicate risk aversion of market participants, in the Queensland and Victoria electricity market. We also relate realized premiums to variables such as spot price levels, volatility, skewness and kurtosis prior to the delivery period. Due to the high correlation of the observed premiums across the regions, we apply a seemingly unrelated regression (SUR) approach. We find that in particular spot price levels, but also skewness and kurtosis of spot prices contribute significantly to the explanation of realized risk premiums.

Carbon Emission Permit Price Volatility Reduction via Financial Options

We develop a stylized model to investigate the impact of financial options on reducing carbon permit price volatility under a cap-and-trade system. The existence of an option market provides a mechanism to hedge the uncertainty of future spot prices and is a stimulus for investment in carbon emission abatement technologies. We show that both the spot price level and the price volatility of carbon permits can be reduced via the trading of financial options, while achieving the emission reduction target. We also show that introducing financial options in a banking environment offers more flexibility to risk management in carbon permit trading.

The pricing of electricity futures: Evidence from the European energy exchange

AbstractThis study investigates the pricing of electricity futures at the European Energy Exchange (EEX) over the period 2002 through 2004. To calculate theoretical contract values, the reduced‐form models of J. J. Lucia and E. S. Schwartz (2002) are used, and a thorough empirical analysis by means of an out‐of‐sample test is conducted for both one‐ and two‐factor models, incorporating a constant non‐zero price of risk. Although the models are proven to capture all basic spot market characteristics and provide an accurate in‐the‐sample fit to observed futures prices, the forecasting performance is subject to biases. For instance, it was found that the relative mispricing depends on both the spot price level and the remaining time‐to‐maturity of the futures contracts. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:387–410, 2007

Stochastic Volatility and Seasonality in Commodity Futures and Options: The Case of Soybeans

We estimate a continuous-time stochastic volatility model using panel data of soybean futures and options on soybean futures. The model of commodity price dynamics is within the class of so-called affine asset pricing models, and option prices are determined using a standard inversion of characteristic functions approach. Our modeling acknowledges that commodities exhibit seasonality patterns in both spot price level and volatility and, hence, the involved commodity dynamics involve stochastic differential equations that are inhomogeneous in time. The estimation method is based on a state space formulation of the model and a quasi maximum likelihood approach. Estimation results are obtained based on weekly observations of soybean futures prices and options prices from the Chicago Board of Trade in the period October 1984 to March 1999. Our empirical results support the conceptual ideas in the theory of storage, though not the view that convenience yields are like timing options.