Development of electricity price hedging with futures

Abstract

Given the recent volatility of electricity prices, this thesis aims to determine if the findings on electricity price hedging using futures are consistent with previous research. This paper will study the effectiveness of futures contracts in the Nordic electricity market in reducing variance and compare the in-sample and out-ofsample hedging ability of the minimum variance hedge computed using naïve, ordinary least squares regression (OLS) and rolling OLS hedge ratios. The empirical results in this paper suggest significant differences between hedging performance, volatility characteristics, and optimal hedge ratios in the Nordic electricity market. Hedging effectiveness varies over time due to unstable correlations between changes in spot and future prices. The out-of-sample hedging effectiveness is limited compared to the in-sample performance; this may be attributed to the high volatility of electricity prices in 2021 and 2022, which resulted in low correlations between spot and future prices. In contrast with previous literature in various other energy markets, we found that static hedge approaches were more effective than a dynamic hedge.