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A model of carbon price interactions with macroeconomic and energy dynamics

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  • Chevallier, Julien

Abstract

This paper develops a model of carbon pricing by considering two fundamental drivers of European Union Allowances: economic activity and energy prices. On the one hand, economic activity is proxied by aggregated industrial production in the EU 27 (as it provides the best performance in a preliminary forecasting exercise vs. other indicators). On the other hand, brent, natural gas and coal prices are selected as being the main carbon price drivers (as highlighted by previous literature). The interactions between the macroeconomic and energy spheres are captured in a Markov-switching VAR model with two states that is able to reproduce the ‘boom–bust’ business cycle (Hamilton (1989)). First, industrial production is found to impact positively (negatively) the carbon market during periods of economic expansion (recession), thereby confirming the existence of a link between the macroeconomy and the price of carbon. Second, the brent price is confirmed to be the leader in price formation among energy markets (Bachmeier and Griffin (2006)), as it impacts other variables through the structure of the Markov-switching model. Taken together, these results uncover new interactions between the recently created EU emissions market and the pre-existing macroeconomic/energy environment.

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Bibliographic Info

Article provided by Elsevier in its journal Energy Economics.

Volume (Year): 33 (2011)
Issue (Month): 6 ()
Pages: 1295-1312

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Handle: RePEc:eee:eneeco:v:33:y:2011:i:6:p:1295-1312

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Web page: http://www.elsevier.com/locate/eneco

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Keywords: Carbon price; Economic activity; Energy prices; Markov-switching model;

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Citations

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Cited by:
  1. Harrison Fell & Beat Hintermann & Herman Vollebergh, 2013. "Carbon content of electricity futures in Phase II of the EU ETS," Working Papers 2013-06, Colorado School of Mines, Division of Economics and Business.
  2. Julien Chevallier & Benoît Sévi, 2014. "On the Stochastic Properties of Carbon Futures Prices," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 58(1), pages 127-153, May.
  3. Lutz, Benjamin Johannes & Pigorsch, Uta & Rotfuß, Waldemar, 2013. "Nonlinearity in cap-and-trade systems: The EUA price and its fundamentals," ZEW Discussion Papers 13-001, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
  4. Chevallier, Julien, 2013. "Variance risk-premia in CO2 markets," Economic Modelling, Elsevier, vol. 31(C), pages 598-605.
  5. Wilfried Rickels & Dennis Görlich & Gerrit Oberst & Sonja Peterson, 2012. "Carbon Price Dynamics – Evidence from Phase II of the European Emission Trading Scheme," Kiel Working Papers 1804, Kiel Institute for the World Economy.
  6. Oscar Carchano & Vicente Medina Martínez & Ángel Pardo Tornero, 2012. "Rolling over EUAs and CERs," Working Papers. Serie AD 2012-15, Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie).
  7. Rita Sousa & Luís Aguiar-Conraria, 2014. "Dynamics of CO2 price drivers," NIPE Working Papers 02/2014, NIPE - Universidade do Minho.
  8. Julien Chevallier & Benoît Sévi, 2012. "On the Stochastic Properties of Carbon Futures Prices," Working Papers halshs-00720166, HAL.
  9. Byun, Suk Joon & Cho, Hangjun, 2013. "Forecasting carbon futures volatility using GARCH models with energy volatilities," Energy Economics, Elsevier, vol. 40(C), pages 207-221.

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