Unknown unknowns in the German-Nordic  electricity price difference

In September 2018, a huge default by an individual trader in the German-Nordic power market led to inquests and demands for fresh funds from market participants, as the Nasdaq exchange and
its customers had to rebuild their defences against defaults in the derivatives markets after they were badly damaged by soured bets from an individual trader.

The German-Nordic electricity price difference (future price) is a wide sense non-stationary series, with a unit-root and with intermittent location-shifts. Using appropriate econometric methods, those defining features of the series could have been asserted empirically before the large price difference occurred in September 2018. Hence it is the magnitude of the locations-shifts in the September that makes them different from earlier breaks, not their nature as «unknown unknowns» for any forecaster or investor who attempted to foresee the development of the price difference based on the information in the historical time series. The use of stationary models with ARCH is likely to lead to underestimation of market price volatility, both in the short term and medium term perspective, maybe allowing too large positions being taken by market operators.

Link to paper with analysis

Normetrics