Selective futures hedging in the Nordic electricity market

• Nordic electricity futures show predictable seasonal bias. • Optimal short (long) hedgers should over-hedge in winter (summer) and under-hedge in summer (winter). • Optimal hedge ratios depend on hedging horizon, season and risk aversion. Electricity futures price can be split into the expected spot price on the maturity date and a risk premium. This risk premium is shown to contain a seasonal behaviour with futures price above (below) expected spot price in winter (summer). Therefore, as futures returns can be partially predicted, the minimum variance hedging approach is not optimal anymore, but for agents with very high degree of risk aversion. We propose a selective hedging strategy based on futures bias forecasts that modifies the pure hedging position with a speculative part depending on the expected futures return and the degree of risk aversion. Using monthly futures contracts from the Nord Pool, we find that the best performing short hedging strategies for moderate or high-risk adverse agents are those with hedge ratios above (below) the minimum variance hedge ratio in the winter (summer) season and the reverse for long hedging strategies.