Three-Regime Threshold Error Correction Models and the Law of One Price: The Case of European Electricity Markets

Abstract

In this paper threshold error correction models (TVECMs) and min-max (MM) models are applied to examine the integration of European electricity markets. The relationships across German, Dutch, British and French forward prices are assessed allowing for the possibility that the convergence in prices may not always be operational. Indeed, interdependences may occur only when the spread in prices between two markets makes it profitable to invest in cross-border contracts. As a main result, allowing for non-linear adjustment dynamics improves the accuracy of the model.

Keywords: Electricity, forward prices, EU market integration, non-linear error correction, min-max process

JEL Classification: C22, C32