Multivariate Volatility Modeling of Electricity Futures

Abstract

We model the dynamic volatility and correlation structure of electricity futures of the European Energy Exchange index. We use a new multiplicative dynamic conditional correlation (mDCC) model to separate long-run from short-run components. We allow for smooth changes in the unconditional volatilities and correlations through a multiplicative component that we estimate nonparametrically. For the short-run dynamics, we use a GJR-GARCH model for the conditional variances and augmented DCC models for the conditional correlations. We also introduce exogenous variables to account for congestion and delivery date effects in short-term conditional variances. We find different correlation dynamics for long- and short-term contracts and the new model achieves higher forecasting performance compared \to a standard DCC model.

Appendix is available at:https://ssrn.com/abstract=2965511

Keywords: Multivariate GARCH, dynamic correlations, multiplicative model, forecasting, electricity futures

JEL Classification: C32, C53, C58