Empirical studies of Nord Pool’s financial market : unbiasedness, risk premiums & hedging

Abstract

The theme of this thesis is empirical studies of Nord Pool’s financial market. Future contract with maturity of one, four and twelve weeks and its underlying spot prices were studied between 1995 to 2009. The volatility of power is exceedingly volatile compared to other assets. Although some of this volatility may be due to seasonal price movements, there is a substantial basis risk in this market. In this thesis, I will discuss two subjects, the unbiasedness hypothesis and hedging. First part addresses the issue whether prices of future contracts can be used as reliable predictors for the future spot prices. The main finding of this section is that Nord Pool’s financial market can be described as a market that has gradually improved itself in terms of market efficiency. There are also some indications for a time-varying risk premium in the future contract. The second part deals with risk management of spot and future contracts. Various hedging models such as OLS, VAR and multivariate GARCH-models were put into use to calculate hedging ratios and hedging efficiency. In this section, it is argued that all hedging models outperformed a naïve hedge and the time-varying hedge ratios gave better results than the constant hedge ratios by using an in-the-sample analysis. However, the time-varying hedging-strategy lost some of its properties when employing an out-of-sample analysis. The hedging efficiency varied between 20 per cent for the shorter contracts and as much as 50 per cent for the longer contracts.