Estimating the commodity market price of risk for energy prices

• Published in: Energy economics Vol. 30; no. 2; pp. 621 - 641
• Main Authors: Kolos, Sergey P., Ronn, Ehud I.
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01-03-2008; Elsevier Science; Elsevier; Elsevier Science Ltd
• Series: Energy Economics
• Subjects: Applied sciences; Commodity markets; Economic data; Electric energy; Energy; Energy economics; Energy industry; Energy market; Energy prices; Exact sciences and technology; Expected returns; Financial management; Fossil fuels and derived products; Future prices; Futures; Gas; General, economic and professional studies; Hedging; Market price of risk; Market prices; Methodology. Modelling; Risk management; Securities prices; Standard deviation; Studies; Energy; Market price of risk; Future prices; Short term; Measurement indicator; Methodology; Energy economy; Risk; Risk analysis; Market price; Long term; Forecasting; Petroleum; Electricity; Price; Natural gas; Time bargain
• ISSN: 0140-9883; 1873-6181
• DOI: 10.1016/j.eneco.2007.09.005

The purpose of this paper is to estimate the “market price of risk” (MPR) for energy commodities, the ratio of expected return to standard deviation. The MPR sign determines whether energy forward prices are upward- or downward-biased predictors of expected spot prices. We estimate MPRs using spot and futures prices, while accounting for the Samuelson effect. We find long-term MPRs generally positive and short-term negative, consistent with positive energy betas and hedging, respectively. In spot electricity markets, MPRs in Day-Ahead Prices agree with short-dated futures. Our results relate risk premia to informed hedging decisions, and futures prices to forecast/expected prices.