Derivative Pricing Premiums and Risk Management in the Nordic Power Market

Abstract

The primary purpose of this thesis was to investigate pricing premiums for derivatives with Nordic power as the underlying asset and to outline whether such premiums influenced hedging strategies. The time period chosen was January 2013 to December 2019, and the financial derivatives analysed were options on futures and weekly-, monthly-, quarterly- and yearly futures contracts. This thesis found that futures prices are biased predictors of the corresponding spot prices, and that significant forward premiums are present in the financial market for Nordic power. Additionally, it was uncovered that the European Market Infrastructure Regulation enforced in 2016 eliminated the use of deferred settlement futures, which ultimately led to many foreign participants leaving the market, overall decreasing the liquidity. This, in combination with the high implied volatility of the underlying asset, caused options to cease trading in a meaningful volume, which ultimately led to their exclusion from future hedging strategies. Hedging strategies for power producers and -suppliers were presented where it was identified that 14 out of 40 offsetting hedging strategies yielded a lower standard deviation and a higher return than the baseline of zero hedging. Finally, as many market participants employ speculation alongside their risk management, speculative investment strategies were presented within the framework of Markowitz’ mean-variance portfolio theory.