Jump Risk Premia in Short-Term Spread Options: Evidence from the German Electricity Market

Abstract

This paper analyzes the valuation of day-ahead Physical Transmission Rights (PTRs) on the German-Dutch interconnector. From a financial perspective, PTRs are options written on the difference between the German and Dutch hourly electricity prices. We propose a model for the valuation of day-ahead PTR options incorporating the unique characteristics of the underlying spread. We empirically test our model for all PTRs between 2001 and 2008, where we model each hour of the day separately. Overall, especially for calm hours, our approach constitutes an adequate model for the valuation of day-ahead PTR options. Empirical results show a negative or zero market price of jump risk for the turbulent hours 8 to 22. These results correspond to risk-loving or risk-neutral investors and indicate that market participants pay a premium for PTRs during peak hours. This premium is based either on increased hedging demand or on speculation.

Keywords: Electricity, Physical Transmission Right, Risk Premium, MCMC

JEL Classification: C13, G13, Q40