Market Making and Electricity Price Formation in Japan

Kanamura, T and Bunn, D W (2022) Market Making and Electricity Price Formation in Japan. Energy Economics. ISSN 0140-9883 (In Press)

Abstract

Market-making, a common trading practice, is often directed by regulators to improve the liquidity in new products, to make their prices more reliable as markers and to encourage new entrants. Establishing its effectiveness is sometimes elusive, however, as market participation and behaviour can be confounded by many special circumstances, especially in energy. We develop an unusual model-based approach in order to establish if a market-making intervention improved the fundamental price formation dynamics. In the context of the Japanese wholesale electricity auction, we develop a dynamic regime switching formulation to account for the distinct effects of buy-side and sell-side volumes on price formation, using temperature as a regime switching driver. The model has a nonlinear functionality that allows it to fit the spiky time series very effectively. The result is clarity that after a market-making intervention in 2017, the buy and sell volumes had more intuitive and distinct effects upon price formation, compared to previously. In addition, temperature information has been more coherently embedded in price and volatility fundamental modelling since the intervention. We argue that the model indicated a more balanced market with buy and sell side regime drivers behaving more consistently with improved market efficiency.

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Item Type: Article
Subject Areas: Management Science and Operations
Date Deposited: 22 Dec 2021 15:47
Date of first compliant deposit: 22 Dec 2021
Subjects: Electricity supply industry
Last Modified: 04 Mar 2022 01:22
URI: https://lbsresearch.london.edu/id/eprint/2178
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