Price volatility in commodity markets with restricted participation

Analyzing commodity market dynamics, we observe that price volatility increases with reduced contract duration. In this paper, we derive a theoretical model depicting the price formation in two markets with altering product granularity. Supplemented by empirical evidence from German electricity markets for hourly and quarter-hourly products, we find that the high price volatility is triggered by restricted participation of suppliers in the market for quarter-hourly products as well as by sub-hourly variations of renewable supply and demand. Welfare implications reveal efficiency losses of EUR 96 million in 2015 that may be reduced if markets are coupled.