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Liquidity and resolution of uncertainty in the European carbon futures market

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  • Kalaitzoglou, Iordanis Angelos
  • Ibrahim, Boulis Maher

Abstract

We investigate whether liquidity introduces or helps resolve uncertainty in Phase I and the first year of Phase II of the European carbon futures market. We propose a distinction between ‘absolute’ or overall liquidity and that which is ‘relative’ to a benchmark. For this purpose, we suggest volume-weighted duration as a natural measure of trading intensity as a proxy for liquidity, and we model it as a rescaled temporal point process. The new model is called Autoregressive Conditional Weighted Duration (ACWD) and is shown to outperform its discrete modelling counterparts. Liquidity is found to play a dual role, with higher relative liquidity introducing uncertainty and higher absolute liquidity accelerating uncertainty resolution, thus, enhancing market efficiency.

Suggested Citation

  • Kalaitzoglou, Iordanis Angelos & Ibrahim, Boulis Maher, 2015. "Liquidity and resolution of uncertainty in the European carbon futures market," International Review of Financial Analysis, Elsevier, vol. 37(C), pages 89-102.
    • Handle: RePEc:eee:finana:v:37:y:2015:i:c:p:89-102
    DOI: 10.1016/j.irfa.2014.11.006
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    2. Katharina Erdmann & Aleksandar Zaklan, 2018. "Linking Cap-and-Trade Systems," DIW Roundup: Politik im Fokus 123, DIW Berlin, German Institute for Economic Research.
    3. Mengyu Zhang & Thanos Verousis & Iordanis Kalaitzoglou, 2022. "Information and the arrival rate of option trading volume," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(4), pages 605-644, April.
    4. Zhong, Meirui & Zhang, Rui & Ren, Xiaohang, 2023. "The time-varying effects of liquidity and market efficiency of the European Union carbon market: Evidence from the TVP-SVAR-SV approach," Energy Economics, Elsevier, vol. 123(C).
    5. Qingfu Liu & Qian Luo & Yiuman Tse & Yuchi Xie, 2020. "The market quality of commodity futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(11), pages 1751-1766, November.
    6. Kalaitzoglou, Iordanis Angelos & Ibrahim, Boulis Maher, 2023. "Market conditions and order-type preference," International Review of Financial Analysis, Elsevier, vol. 87(C).
    7. Katharina Erdmann & Aleksandar Zaklan & Claudia Kemfert, 2019. "Linking Cap-and-Trade Systems and Green Finance," Vierteljahrshefte zur Wirtschaftsforschung / Quarterly Journal of Economic Research, DIW Berlin, German Institute for Economic Research, vol. 88(2), pages 89-100.
    8. Chevallier, Julien & Goutte, Stéphane & Ji, Qiang & Guesmi, Khaled, 2021. "Green finance and the restructuring of the oil-gas-coal business model under carbon asset stranding constraints," Energy Policy, Elsevier, vol. 149(C).
    9. Julien Chevallier & Stéphane Goutte & Khaled Guesmi, 2019. "Climate finance and the restructuring of the oil-gas-coal business model under carbon asset stranding constraints," Working Papers halshs-02106113, HAL.
    10. Chang, Kai & Chen, Rongda & Chevallier, Julien, 2018. "Market fragmentation, liquidity measures and improvement perspectives from China's emissions trading scheme pilots," Energy Economics, Elsevier, vol. 75(C), pages 249-260.
    11. Rui Zhu & Liyu Long & Yinghua Gong, 2022. "Emission Trading System, Carbon Market Efficiency, and Corporate Innovations," IJERPH, MDPI, vol. 19(15), pages 1-22, August.

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    More about this item

    Keywords

    instantaneous liquidity; Marked duration; Temporal marked point process; Carbon market;
    All these keywords.

    JEL classification:

    • C41 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Duration Analysis; Optimal Timing Strategies
    • C46 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Specific Distributions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • Q40 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - General

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