infonet-economy

Increasing interconnectivity between electricity wholesale markets requires an
efficient allocation scheme in order to provide access to scarce cross-border
transmission capacities. In both the US and Europe, existing schemes have
primarily induced economically inefficient interconnector use given that flows have
to be nominated prior to spot market clearing. By contrast, the market coupling
mechanisms recently rolled out in parts of Europe avoid these inefficiencies by
implicitly allocating cross-border transmission capacity upon spot market clearance. In this paper, we show that these institutional aspects of market design clearly manifest in the empirical dynamics of both electricity spot and derivatives prices, and hence, do have important implications for pricing and hedging in these markets. Since traditional reduced-form models fail to reproduce such effects of market microstructure, we employ a fundamental multi-market model for electricity pricing in order to analyze how the key stylized facts of electricity prices are impacted by the different allocation schemes.