Modeling Forward Premia in the PJM Electricity Market

Abstract

This study examined the empirical relationship between spot and forward prices in the PJM electricity market using hourly data. Previous theoretical models and empirical studies on forward premia were synthesized to thoroughly analyze five years of recent data in the PJM markets. Forward premia were found to be statistically significant and correlated with the variance and skewness of spot prices as well as the two interaction variables of gas storage with measures of hot or cold temperature. Forward premia were also found to vary systematically throughout the day in conjunction with specific economic measures of risk: the conditional volatility of unexpected changes in demand, spot price, and total revenue. The existence of forward premia initially suggested inefficiencies in the PJM electricity markets. However, the results in this study support the hypothesis that prices are determined by rational risk-averse economic agents.