The Hedging Performance of Electricity Futures on the Nordic Power Exchange Nord Pool

The Nordic Power Exchange (Nord Pool), the first multinational exchange for electricity trading, has existed since January 1996. Spot and futures contracts are traded on this exchange and its typical characteristics are very high volatility as well as non-normally distributed returns. In this paper I look at electricity futures and how they can be used for short term hedging in the spot market. I study the minimum variance hedge ratio and how it can be estimated in different ways. The traditional naive hedge and the OLS hedge are compared out-of-sample to more elaborate moving average and GARCH hedges. The empirical results indicate some gains from hedging with futures despite the lack of straight-forward arbitrage possibilities in the electricity market. Furthermore, I find that the relative performance of the different variance minimizing hedges depends on whether unconditional or conditional variances are studied.