Journal of Energy Markets

Risk.net

The information premium for non-storable commodities

Fred Espen Benth, Thilo Meyer-Brandis

ABSTRACT

For non-storable commodities, forward-looking information about market conditions is not necessarily incorporated into today's prices, and the standard assumption that the information filtration is generated by the asset is fundamentally wrong. Electricity and weather are the typical markets we have in mind. We discuss pricing of forward contracts on non-storable commodities based on an enlargement of the information filtration. This method is able to incorporate future information of the spot, which is not accounted for in the present spot price behavior. The notions of information drift and premium are introduced, and we argue that a significant part of the supposedly irregular market price of risk observed in electricity markets is, in reality, due to information mis-specification in the model. Some examples based on Brownian motion and Lévy processes and the theory of initial enlargement of filtrations are considered. In these examples we provide some insights into the nature of the information drift and premium being relevant for the electricity markets. The examples include cases where electricity forwards.

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