THE INFORMATION PREMIUM IN ELECTRICITY MARKETS

Abstract

Electricity is a commodity which is non-storable, and therefore difficult to move forward in time. Hence, forward looking information about market conditions is not necessarily incorporated in today's prices, and the typical assumption that the information filtration is generated by the asset is fundamentally wrong. We discuss pricing of forward contracts in the electricity market based on an enlargement of the information filtration. The method is able to incorporate future information of the spot, which is not accounted for in the present spot price behaviour. The notion of the information yield implied from the introduction of an information drift due to knowledge about the future spot behaviour and the corresponding information premium are introduced, and we argue that significant parts of the supposedly irregular market price of risk in electricity markets is in reality due to information miss-specification in the model. Some examples based on Brownian motion and Lévy processes and the theory of initial enlargement of filtrations are considered, where we are able to shed some insight into the nature of the information yield and the information premium relevant for the electricity markets. The examples include cases where we take future temperature predictions and knowledge of the long-term level of the spot into account.