Testing for Market Eciency with Transactions Costs: An Application to Convergence Bidding in Wholesale Electricity Markets

Abstract

With risk neutral traders and zero transactions costs, the expected value of the dierence between the current forward price and the spot price at the delivery date of the forward contract should be zero. Accounting for the transaction costs associated with trading in these commodity markets invalidates this result. We develop statistical tests of the null hypothesis that certain forms of protable arbitrage exist in the presence of trading costs. We implement these tests using the day-ahead forward and real-time spot locational marginal prices from California’s wholesale electricity market and use them to construct an estimate of the transactions costs associated with trading in these markets. During our sample period of April 1, 2009 to December 31, 2012, we observe the introduction of explicit virtual bidding, which was aimed at reducing the transactions costs associated with exploiting dierences between forward and spot