Journal of Energy Markets

Risk management and portfolio optimization for gas- and coal-fired power plants in Germany: a multivariate GARCH approach

Reinhard Madlener and Georgios Charalampous

  • The hedging effectiveness of EEX-traded futures for power generation is evaluated.
  • We search the best contracts for a joint hedging fuel input and electricity output.
  • The BEKK model, a multivariate GARCH model , is used to assess hedging performance.
  • The optimal spot and futures contract mixes for risk minimization are determined.


We investigate the hedging effectiveness of energy derivatives traded at the European Energy Exchange (EEX), which can be used for mitigating the risk exposure of gas- and coal-fired power plants in Germany. Our aim is to identify the optimum forward contract for simultaneously hedging power output and fuel input price risk. The optimum hedging contract for each commodity is identified with the help of a multivariate GARCH model (D-BEKK model). We find that it is more prudent to hedge the spot electricity and coal prices with long-term contracts, whereas for natural gas prices there is evidence that short-term futures enable higher hedging effectiveness. Further, with all futures contracts available we construct portfolios and compare the hedging performance with that of the individual futures contracts. More specifically, we first identify the point at which the combination of spot and forward prices gives the maximum reduction of risk exposure and then investigate the impact of time-varying risk premiums on the spot-forward price relationship. Finally, we compute portfolio weights for different risk levels that reveal the optimal mix of spot and futures contracts. The results show that electricity and coal both produce negative returns, whereas for natural gas we are able to construct economically viable portfolios, albeit with low returns.