Do jumps matter for volatility forecasting? Evidence from energy markets

This paper characterizes the dynamics of jumps and analyzes their importance for volatility forecasting. Using high-frequency data on four prominent energy markets, we perform a model-free decomposition of realized variance into its continuous and discontinuous components. We find strong evidence of jumps in energy markets between 2007 and 2012. We then investigate the importance of jumps for volatility forecasting. To this end, we estimate and analyze the predictive ability of several Heterogenous Autoregressive (HAR) models that explicitly capture the dynamics of jumps. Conducting extensive in-sample and out-of-sample analyses, we establish that explicitly modeling jumps does not significantly improve forecast accuracy. Our results are broadly consistent across our four energy markets, forecasting horizons, and loss functions

‘Nudging’ energy users: regulatory measures to address the risk of aggregate peak demand in European electricity markets

For decades regulators in the energy sector have focused on facilitating the maximisation of energy supply in order to meet demand through liberalisation and removal of market barriers. The debate on climate change has emphasised a new type of risk in the balance between energy demand and supply: excessively high energy demand brings about significantly negative environmental and economic impacts. This is because if a vast number of users is consuming electricity at the same time, energy suppliers have to activate dirty old power plants with higher greenhouse gas emissions and higher system costs. The creation of a Europe-wide electricity market requires a systematic investigation into the risk of aggregate peak demand. This paper draws on the e-Living Time-Use Survey database to assess the risk of aggregate peak residential electricity demand for European energy markets. Findings highlight in which countries and for what activities the risk of aggregate peak demand is greater. The discussion highlights which approaches energy regulators have started considering to convince users about the risks of consuming too much energy during peak times. These include ‘nudging’ approaches such as the roll-out of smart meters, incentives for shifting the timing of energy consumption, differentiated time-of-use tariffs, regulatory financial incentives and consumption data sharing at the community level.

Closed form approximations for spread options

This article expresses the price of a spread option as the sum of the prices of two compound options. One compound option is to exchange vanilla call options on the two underlying assets and the other is to exchange the corresponding put options. This way we derive a new closed form approximation for the price of a European spread option and a corresponding approximation for each of its price, volatility and correlation hedge ratios. Our approach has many advantages over existing analytical approximations, which have limited validity and an indeterminacy that renders them of little practical use. The compound exchange option approximation for European spread options is then extended to American spread options on assets that pay dividends or incur costs. Simulations quantify the accuracy of our approach; we also present an empirical application to the American crack spread options that are traded on NYMEX. For illustration, we compare our results with those obtained using the approximation attributed to Kirk (1996, Correlation in energy markets. In: V. Kaminski (Ed.), Managing Energy Price Risk, pp. 71–78 (London: Risk Publications)), which is commonly used by traders.

Demand response experience in Europe: policies, programmes and implementation

Over the last few years, load growth, increases in intermittent generation, declining technology costs and increasing recognition of the importance of customer behaviour in energy markets have brought about a change in the focus of Demand Response (DR) in Europe. The long standing programmes involving large industries, through interruptible tariffs and time of day pricing, have been increasingly complemented by programmes aimed at commercial and residential customer groups. Developments in DR vary substantially across Europe reflecting national conditions and triggered by different sets of policies, programmes and implementation schemes. This paper examines experiences within European countries as well as at European Union (EU) level, with the aim of understanding which factors have facilitated or impeded advances in DR. It describes initiatives, studies and policies of various European countries, with in-depth case studies of the UK, Italy and Spain. It is concluded that while business programmes, technical and economic potentials vary across Europe, there are common reasons as to why coordinated DR policies have been slow to emerge. This is because of the limited knowledge on DR energy saving capacities; high cost estimates for DR technologies and infrastructures; and policies focused on creating the conditions for liberalising the EU energy markets.

The importance of the volatility risk premium for volatility forecasting

In this paper, we study the role of the volatility risk premium for the forecasting performance of implied volatility. We introduce a non-parametric and parsimonious approach to adjust the model-free implied volatility for the volatility risk premium and implement this methodology using more than 20 years of options and futures data on three major energy markets. Using regression models and statistical loss functions, we find compelling evidence to suggest that the risk premium adjusted implied volatility significantly outperforms other models, including its unadjusted counterpart. Our main finding holds for different choices of volatility estimators and competing time-series models, underlying the robustness of our results.

China and Kazakhstan’s oil and gas partnership at the start of the twenty-first century

Over the past decade, cooperation between China and Kazakhstan in the oil and gas sector has developed significantly. For China, security of its energy supply is a key strategic objective. This paper analyzes the evolution of Sino-Kazakh oil and gas relations, assesses their long-term prospects, and explores how Chinese demand for oil and gas could divert Kazakhstan’s hydrocarbon resources from other energy markets. The netback approach has been used to assess the prices that China will need to offer other producers in Kazakhstan. Sino-Kazakh energy and economic cooperation could create a good basis for free economic zones and development of beneficial ties for both countries.