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Improving liquidity in emission trading schemes

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  • Jihun Kim
  • Kwangwoo Park

Abstract

This paper constructs a model of an Emission Trading Scheme (ETS) market using bid‐ask spreads. We show that when such a market is dominated by a small number of traders with substantial market power, they tend to maximize their profits by widening bid‐ask spreads, thereby reducing market liquidity. We argue that adding more market participants, including derivatives traders, can alleviate this illiquidity problem. Policy changes at the European Union's ETS illustrate our theory, as the market significantly increased liquidity by enacting liquidity‐provision policies to attract more participants as it transitioned from Phase 1 to Phase 2.

Suggested Citation

  • Jihun Kim & Kwangwoo Park, 2021. "Improving liquidity in emission trading schemes," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 41(9), pages 1397-1411, September.
    • Handle: RePEc:wly:jfutmk:v:41:y:2021:i:9:p:1397-1411
    DOI: 10.1002/fut.22220
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    References listed on IDEAS

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    Cited by:

    1. Roy Kouwenberg & Chenglong Zheng, 2023. "A Review of the Global Climate Finance Literature," Sustainability, MDPI, vol. 15(2), pages 1-32, January.

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