Electricity Spot and Derivatives Pricing under Market Coupling
School of Finance Working Paper Series
Increasing interconnectivity between electricity wholesale markets requires an eﬃcient allocation scheme in order to provide access to scarce cross-border transmission capacities. The explicit schemes have primarily induced economically ineﬃcient interconnector use given that ﬂows have to be nominated prior to spot market clearing. By contrast, the market coupling mechanisms recently rolled out in parts of Europe avoid these ineﬃciencies by implicitly allocating cross-border transmission capacity upon spot market clearance. In this paper, we show that these institutional aspects of market design clearly manifest in the empirical dynamics of both electricity spot and derivatives prices, and hence, do have important implications for pricing and hedging in these markets. Since traditional reduced-form models fail to reproduce such eﬀects of market microstructure, we employ a fundamental multi-market model for electricity pricing in order to analyze how the key stylized facts of electricity prices are impacted by the diﬀerent allocation schemes.
Energy Market Coupling
Multi-Market Fundamental Model.
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