Showing papers on "Spot contract published in 1998"

Valuation of Commodity Futures and Options under Stochastic Convenience Yields, Interest Rates, and Jump Diffusions in the Spot

Abstract: This paper investigates the effects of stochastic convenience yields, stochastic interest rates, and jumps in the spot price on the pricing of commodity futures, forwards, and futures options. Numerical examples show that one-factor prices differ materially from the stochastic convenience yield two-factor prices when convenience yield is considerably above its long-term average. The extension to a three-factor model with stochastic interest rates leads to a different futures price but the forward price is unchanged. The extension ofthe three-factor model to include jumps in the spot price process does not affect forward or futures prices but it can have an impact on options prices. The model is applied to price the present value of future cash flows from a real asset.

Pricing of Options on Commodity Futures with Stochastic Term Structures of Convenience Yields and Interest Rates

Abstract: We develop a model to value options on commodity futures in the presence of stochastic interest rates as well as stochastic convenience yields. In the development of the model, we distinguish between forward and future convenience yields, a distinction that has not been recognized in the literature. Assuming normality of continuously compounded forward interest rates and convenience yields and log-normality of the spot price of the underlying commodity, we obtain closed-form solutions generalizing the Black-Scholes/Merton's formulas. We provide numerical examples with realistic parameter values showing that both the effect of introducing stochastic convenience yields into the model and the effect of having a short time lag between the maturity of a European call option and the underlying futures contract have significant impact on the option prices.

Spot Prices, Option Prices, and Water Markets: An Analysis of Emerging Markets in California

Abstract: Most of the discussion of water markets revolves around the concept of trading permanent water rights, which implicitly assumes that the water property rights are adequately defined and transaction costs are not a significant barrier to trade. While this situation is relevant to several countries and areas in the U.S., there are many other regions where the transaction costs of trading permanent water rights are prohibitive. Given excessive costs for water rights trades, there is still significant potential for the market reallocation of water, using annual spot markets for times of scarcity and option markets for longer-term contracts.

Spot pricing of capacities for generation and transmission of reserve in an extended Poolco model

Abstract: The Poolco model is emerging as one of the most acceptable options for organizing the spot market of electricity. Although the model represents a reasonable and safe transition from present industry practices to what is required in a competitive electricity market, many important issues remain to be resolved. In particular, issues regarding reliability related services are of a special concern to the industry. This paper is devoted to the issue of reserve service delivery and pricing. The Poolco model is extended in this paper to include spot pricing of reserve generation and transmission capacities, as well as demand side bidding. In the authors' extended model, suppliers submit bids for power as well as for reserve capacities. A new formulation of the extended security constrained economic dispatch which allocates both power and reserve generation resources is presented in this paper. The dispatch of the resources is constrained by limitations of system transmission capacities. The proposed formulation is considered to be relevant not only in the Poolco, but in a more general setup. An illustrative example is used to introduce concepts and present results. Finally, some general issues' regarding formats of proposals, balance of payments and uniqueness of the prices that apply equally to both the original and extended Poolco models are discussed.

Market Efficiency and Natural Selection in a Commodity Futures Market

Abstract: While the literature usually justifies informational efficiency in the context of rationality, this article shows informational efficiency by applying the evolutionary idea of natural selection. In a dynamic futures market, speculators are assumed to merely act upon their predetermined trading types (buyer or seller), their predetermined fractions of wealth allocated for speculation, and their inherent abilities to predict the spot price, reflected in their distributions of prediction errors with respect to the spot price. This article shows that the proportion of time that the futures price equals the spot price converges to one with probability 1. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Regime switching and cointegration tests of the efficiency of futures markets

Abstract: Many researchers have found that spot and futures prices are not cointegrated in some commodity markets, or they are cointegrated but not with a cointegrating vector (1, −1). One interpretation is that disturbances to excess returns have a unit root persistence, which implies that spot and futures prices do not move together one-for-one in the long run. To provide an alternative explanation for this finding, this article proposes a regime switching model of spot prices that can be viewed in the same framework as Fama and French (1988). Based on this model, Monte Carlo experiments are performed to show that tests for cointegration and estimates of the cointegrating vector are likely to be biased when a sample contains infrequent changes in regime. Taking these shifts into account, the null hypothesis that spot and futures prices are cointegrated and move together one-for-one in the long run can no longer be rejected. © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18:871–901, 1998

Electricity spot price forecasting as a part of energy management in de-regulated power market

Abstract: A method for spot price forecasting in electricity exchange is presented. In the beginning of the paper, the practices of the electricity exchange of Finland are described, and a brief presentation is given on the different contracts, or electricity products, available in the spot market. For comparison, the Nordic electricity exchange is also discussed. The structure of the forecasting model, based on time series analysis, is presented, and its validity is tested using real case data obtained from the Finnish power market. The spot price forecasting model is a part of a larger computer system for distribution energy management (DEM) in a de-regulated power market.

Short Selling, Unwinding, and Mispricing

Abstract: This paper highlights the impact of short selling restrictions and early unwinding opportunities on the relation between futures and| spot prices. Within a multiperiod equilibrium model, the influence of optimal arbitrage trading on the mispricing is analyzed. Among| others, optimal arbitrage trading is shown to lead to path dependent mispricing and persistent undervaluation of futures contracts. The hypotheses of the model are tested using intraday data. Results concerning level, mean reversion and path dependence of the mispricing are provided. The empirical evidence suggests that short selling restrictions and early unwinding opportunities are very influential factors for the mispricing behavior.

Pricing term structure risk in futures markets

Abstract: One-period expected returns on futures contracts with different maturities differ because of risk premia in the spreads between futures and spot prices. We analyze the expected returns for futures contracts with different maturities using the information that is present in the current term structure of futures prices. A simple affine one-factor model that implies a constant covariance between the pricing kernel and the cost-of-carry cannot be rejected for heating oil and German Mark futures contracts. For gold and soybean futures, the risk premia depend on the slope of the current term structure of futures prices, while for live cattle futures, the evidence is mixed.

A simulation based approach to pricing reactive power

Abstract: We investigate the simulation of real and reactive power spot markets. While spot pricing of real power remains a viable option for the creation of a power system market, the future of a reactive power spot market remains cloudy. The large capital investment portion needed in pricing reactive power as well as the highly volatile nature of reactive power spot prices makes the creation of such a market difficult. In spite of this, a portion of the pricing scheme that is used for reactive power will likely be based on the spot pricing approach as this provides the most accurate signal for near real time system operation. The paper builds on a simple modification to the standard optimal power flow (OPF) in order to simulate the spot markers for real and reactive power. To achieve this, price dependent load models are introduced for both real and reactive power.

Backwardation in Oil Futures Markets: Theory and Empirical Evidence

Abstract: Oil futures prices are often below spot prices. This phenomenon, known as strong backwardation, is inconsistent with Hotelling's theory under certainty that the net price of an exhaustible resource rises over time at the rate of interest. We introduce uncertainty and characterize oil wells as call options. We show that (1) production occurs only if discounted futures are below spot prices, (2) production is non-increasing in the riskiness of future prices, and (3) strong backwardation emerges if the riskiness of future prices is sufficiently high. The empirical analysis indicates that U.S. oil production is inversely related and backwardation is directly related to implied volatility.

Market efficiency in the Spanish derivatives markets: An empirical analysis

Abstract: This paper analyzes Granger caUSAlity between daily prices of the Spanish stock index (Ibex 35) and its futures contract using Johansen cointegration methodology. The study differentiates between short-run and long-run caUSAlity. The empirical results prove that, in the short run, the futures price causes the spot price. However, the opposite is not true. On the other hand, long-run caUSAlity is embodied in the response of futures prices after deviations from the long-run equilibrium. These results say that during the period of study, the Spanish futures market behaved as an efficient market.

Australian commodity futures prices : evidence on forecast power, premiums, and the theory of storage

Abstract: There are two popular theories that serve to explain the behaviour of futures prices. The Theory of the Price of storage explains the spread between the current spot and futures price as a function of net marginal storage costs. The alternative view expresses a futures price as the sum of an expected spot price and an expected premium. While the Theory of storage is not controversial, there is little agreement as to whether futures prices contain either of these two components. In this thesis, both models will be used to study the behaviour of greasy wool, trade steers, gold and silver futures •prices. As a prelude to this, a review of the literature related to these theories is presented. In particular, it is shown that difficulties in verifying the normal backwardation hypothesis may be partially due to definitional problems. Statistical tests are applied to the data. The results obtained are consistent with French's [1986] proposition that the power to detect expected premia or predict future spot prices is related to the storage characteristics of the commodity. More specifically, the tests conducted provide results consistent with the predictions of the Price of storage theory, while more powerful tests must be conducted before only marginal evidence of expected premia or reliable forecast power is found.

The regulating power market on the Nordic power exchange Nord Pool. An econometric analysis

Abstract: What differentiates the structure of Nord Pool from other power exchanges around the world is the way the balance from the spot market is maintained until the actual, physical delivery takes place, via the regulating power market in Norway. This paper reveals the pattern of the prices on the regulating power market, by analysing the cost of being unable to fulfil the commitments made on the spot market. Some power producers with unpredictable fluctuations (e.g. wind) will need to buy regulation services. The disclosed pattern implies that these producers must pay a limited premium of readiness in addition to the spot price; this premium is independent of the amount of regulation. The level of the premium of readiness for down-regulation is shown to be strongly influenced by the level of the spot price. On the other hand, it is demonstrated that the premium for up-regulation is less correlated to the spot price. Furthermore, it is found that the amount of regulation affects the price of regulating power for up-regulation more strongly than it does for down-regulation. The disclosed cost of using the regulating power market is a quadratic function of the amount of regulation. This asymmetric cost may encourage bidders with fluctuating production to be more strategic in their way of bidding on the spot market. By using such strategies the extra costs (for example wind power) needed to counter unpredictable fluctuations may be limited.

A Fractional Cointegration Approach to Testing Mean Reversion Between Spot and Forward Exchange Rates: A Case of High Frequency Data with Low Frequency Dynamics

Abstract: This paper applies a relatively new but generalised concept of fractional cointegration to shed some light on the validity of a long-run relationship between high frequency daily spot and the lagged forward Australian-US dollar exchange rate. An investigation of the stochastic properties of these rates reveals that, while the relationship is not cointegrated in their logs, they appear to be fractionally cointegrated if we allow for mean reverting processes that are CI(1, d) with 0

Asymmetric information in commodity futures markets: Theory and empirical evidence

Abstract: This article examines the theoretical and empirical implications of asymmetric information in commodity futures markets. In particular, it formulates and tests a theoretical model that recognizes two distinct categories of traders: hedgers, who participate in both spot and futures markets, and speculators, who participate only in the futures market. Speculators are assumed to possess differential information about the realized values of selected random variables. Multiperiod futures market equilibria are derived under competitive conditions, and the ability of futures markets to forecast changes in equilibrium spot market prices are examined. The key variable is shown to be the randomness and informational asymmetry in the aggregate supply by participating hedgers in the spot market, whose absence turns out to be the major determinant of the revelation of informational asymmetry. Moreover, under the assumption of independence of error forecasts for prices and spot market supplies, it is shown that futures market equilibrium ends up with linear expressions for prices and futures contract volumes. These linear expressions are then used to develop empirically testable models. The main empirical implications in these models revolve around the role of the basis as a predictor of future spot price changes. The paper provides an empirical investigation of these implications, using three commodities traded on the Winnipeg Commodity Exchange (WCE). © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18:803–825, 1998

Prediction of short-term natural gas prices using econometric and neural network models

Abstract: During the last decade, the natural gas industry underwent a thorough deregulation process after being subjected to federal oversight for more than 40 years. Federal deregulation provided the basis for a new market, which is now more than ever before being driven by competition in the production, transportation and distribution sectors. Now, lack of price transparency causes high fluctuations in the spot market, which exposes market participants to a considerable price risk. Two strategies are necessary for successful price risk management: fundamental analysis, which attempts to understand the market principles and interactions; and quantitative analysis, which develops models to predict price developments using the fundamental analysis as a basis. A need for short-term solutions is now obvious. Therefore, this work, on the one hand, gives a comprehensive description of the current state and market operations of the natural gas industry. On the other hand, the understanding of the natural gas industry obtained in the fundamental analysis provided the background for the development of two models for day-to-day price prediction. An econometric and a neural network model were chosen as the best solutions. For practical application purposes, the prediction performance of the models was tested in a simulated trading scenario and compared to a best and worst case scenario. We found that both models created profits during the time of the test. The neural network model showed better results than the econometric model. Also, in comparison to a scenario with perfect prediction quality and a "guessing" scenario, the results were very pleasing. These models can provide a valuable, supportive tool for trading in a speculative environment.

Inovações contratuais em mercados futuros: o caso do boi gordo na BM&F

Abstract: This paper analyzes the live cattle futures markets in the Commodities and Futures Exchange (BM&F), Brazil, in order to test the effect of contractual innovations and other exogenous variables with regard to the level of positions (open interest) and negotiation over the 1993-96 period. The former contract design specified the liquidation by physical deliveries, which induced problems associated with opportunistic behavior, monitoring, delivery costs and, hence, high transaction costs to traders. The first contractual innovation attempted to reduce those costs by centralizing deliveries to a single point and the second one by eliminating the delivery process, altogether making use of the cash settlement mechanism based on a price index. The tests were performed using structural and time-series regressions specifying the first difference of the daily open interest as an endogenous variable. The effects of both innovations, measured by dummy variables, were positive and significant. Market impact costs (part of the ex ante transaction costs) and spot price volatility (measured by the conditional variance in a GARCH model) were also significant, showing negative and positive effects, respectively.

Managing Transmission Risk: The Theory of Spatial Hedging and Arbitrage

Abstract: The spatial variation in electricity spot prices in competitive markets is complex and counter-intuitive, and qualitatively different from other commodity markets. Even when transmission is only congested between two locations, it can result in price variations all over the system. In theory, market participants could use futures markets to eliminate the financial risks that arise from spatial price variations. In practice however, while physical spot markets for electricity will exist at many locations in the power system, liquid futures markets will exist at only a small fraction of these locations. This report shows how one may manage or eliminate transmission risk using relatively few liquid futures markets. Locational hedging portfolios and synthetic locational futures contracts can be constructed by taking a precisely determined position at time 0 in all the futures markets, and taking another precisely determined position at a later time in the spot markets. The same idea is also used to realize arbitrage opportunities if such opportunities exist. While this is a well known risk management strategy for other commodities, it is non-trivial for electricity because of the requirements imposed by network flows. Based on rigorous formulas, the report presents simple risk management rules of thumb to detect opportunities for hedging and arbitrage.

Decomposition model of optimal spot pricing and interior point method implementation

Abstract: Optimal pricing for real and reactive power is a very important content in a deregulation environment. This paper summarises the optimal pricing problem as an extended optimal power flow problem. Then, spot prices are decomposed into different components reflecting various ancillary services. The deviation of a decomposition model is given in detail. The primary-dual interior point method is applied to avoid "go" "no go" gauge. In addition, the proposed approach can be extended to cater for other types of ancillary services.

Process and system for management of electrical power supply

Abstract: A computer implemented tool forecasts the spot price of electric power in a deregulated market and the amounts of power that may be traded in this market. The computer implemented tool makes these forecasts at different delivery points, providing probabilistic distributions for spot prices and trading, to allow proper risk management of power supply within the electricity network.

Volatility, Storage and Convenience: Evidence from Natural Gas Markets

Abstract: This papers tests a theoretical implication of the theory of storage. We examine the U.S. natural gas market over a period of extensive change in market structure brought about by regulatory action. We motivate and test the hypothesis that the change in market structure increased spot price volatility. The theory of storage implies that a shift to a higher volatility state leads to an increase in convenience yield and therefore, an increase in the use of storage. Using a switching ARCH model, which allows the ARCH parameters to be state dependent, we find evidence that volatility of natural gas prices increased with the change in market structure. We also find that the switch to a higher volatility state is associated with investment in additional storage capacity.

Nonparametric Modeling of U.S. Interest Rate Term Structure Dynamics and Implications on the Prices of Derivative Securities

Abstract: This paper develops a nonparametric model of interest rate term structure dynamics based on a spot rate process that permits only positive interest rates and a market price of interest rate risk that precludes arbitrage opportunities. Both the spot rate process and the market price of interest rate risk are nonparametrically specified so that the model allows for maximum flexibility in fitting into the data. Marginal density of interest rates and historical term structure data are exploited to provide robust estimation of the nonparametric term structure model. The model is implemented using U.S. data, and the estimation results are compared to those in available literature. Empirical results not only provide strong evidence that most traditional spot rate models and market prices of interest rate risk are misspecified, but also confirm that the nonparametric model generates significantly different term structures and prices of common derivatives.

Experimental study of forward and spot markets: contract failure as a contributing factor of vertical integration

Abstract: A probability of a partner not fulfilling his forward contract obligations (contract failure) increases in a transition economy This project investigates the process of price and quantity discovery in a laboratory setting when there is (1) an endogenous choice between forward and spot market institutions and vertical integration; and (2) a certain probability of forward contract failure The results suggest that in some cases a contract failure creates incentives to integration To develop a system, which efficiently allocates resources, the state policy should be oriented toward strengthening the legal system and developing of the spot market, which may act like an insurance mechanism for the failed forward trades