Using Binary Prediction Markets as Hedging Instruments: Strategies for Renewable Generators

Renewable energy sources face volumetric risk in their revenue streams, in any electricity sale structure, due to changeability associated with weather conditions. Weather/power derivatives are often employed to hedge against such financial risks. This letter proposes that a binary prediction market, if is adequately liquid, has the potential to resemble the function of such derivatives to improve the financial profile of renewable sources. The size and the price of shares (contracts) to be purchased by the renewable generator are determined analytically in the methodology of this paper. To this end, two different approaches have been considered: the indifference utility condition and the maximisation of utility function to reflect different risk preferences of investors.