Risk Management and Portfolio Optimization for Gas- and Coal-Fired Power Plants in Germany: A Multivariate GARCH Approach

26 Pages Posted: 14 Jun 2016

See all articles by Georgios Charalampous

Georgios Charalampous

International Hellenic University (IHU)

Reinhard Madlener

RWTH Aachen University

Date Written: May 19, 2016


We investigate the hedging effectiveness of energy derivatives traded at the European Energy Exchange (EEX), which can be used for mitigating the risk exposure of gas- and coal-fired power plants in Germany. Our aim is to identify the optimum forward contract for simultaneously hedging power output and fuel input price risk. The optimum hedging contract for each commodity is identified with the help of a multivariate GARCH model (D-BEKK model). We find that it is more prudent to hedge the spot electricity and coal prices with long-term contracts, whereas for natural gas prices there is evidence that short-term futures enable higher hedging effectiveness. Further, with all futures contracts available we construct portfolios and compare the hedging performance with that of the individual futures contracts. More specifically, we first identify the point at which the combination of spot and forward prices gives the maximum reduction of risk exposure and then investigate the impact of time-varying risk premiums on the spot-forward price relationship. Finally, we compute portfolio weights for different risk levels that reveal the optimal mix of spot and futures contracts. The results show that electricity and coal both produce negative returns, whereas for natural gas we are able to construct economically viable portfolios, albeit with low returns.

Keywords: energy derivatives, hedging effectiveness, BEKK model, semblance analysis

Suggested Citation

Charalampous, Georgios and Madlener, Reinhard, Risk Management and Portfolio Optimization for Gas- and Coal-Fired Power Plants in Germany: A Multivariate GARCH Approach (May 19, 2016). Journal of Energy Markets, Vol. 9, No. 2, 2016. Available at SSRN: https://ssrn.com/abstract=2795033

Georgios Charalampous (Contact Author)

International Hellenic University (IHU) ( email )

14th km Thessaloniki
Thermi, Thessaloniki 57001

Reinhard Madlener

RWTH Aachen University ( email )

School of Business and Economics / E.ON ERC
Mathieustraße 10
Aachen, 52074
+49 241 80 49 820 (Phone)
+49 241 80 49 829 (Fax)

HOME PAGE: http://www.eonerc.rwth-aachen.de/fcn

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