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Options introduction and volatility in the EU ETS

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  • Chevallier, Julien
  • Le Pen, Yannick
  • Sévi, Benoît

Abstract

To improve risk management in the European Union Emissions Trading Scheme (EU ETS), the European Climate Exchange (ECX) has introduced option instruments in October 2006. The central question we address is: can we identify a potential destabilizing effect of the introduction of options on the underlying market (EUA futures)? Indeed, the literature on commodities futures suggest that the introduction of derivatives may either decrease (due to more market depth) or increase (due to more speculation) volatility. As the identification of these effects ultimately remains an empirical question, we use daily data from April 2005 to April 2008 to document volatility behavior in the EU ETS. By instrumenting various GARCH models, endogenous break tests, and rolling window estimations, our results overall suggest that the introduction of the option market had the effect of decreasing the level of volatility in the EU ETS while impacting its dynamics. These findings are fairly robust to other likely influences linked to energy and commodity markets.

Suggested Citation

  • Chevallier, Julien & Le Pen, Yannick & Sévi, Benoît, 2011. "Options introduction and volatility in the EU ETS," Resource and Energy Economics, Elsevier, vol. 33(4), pages 855-880.
    • Handle: RePEc:eee:resene:v:33:y:2011:i:4:p:855-880
    DOI: 10.1016/j.reseneeco.2011.07.002
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    Cited by:

    1. Panagiotis G. Papaioannou & George P. Papaioannou & Kostas Siettos & Akylas Stratigakos & Christos Dikaiakos, 2017. "Dynamic Conditional Correlation between Electricity and Stock markets during the Financial Crisis in Greece," Papers 1708.07063, arXiv.org.
    2. Zhao, Xin-gang & Jiang, Gui-wu & Nie, Dan & Chen, Hao, 2016. "How to improve the market efficiency of carbon trading: A perspective of China," Renewable and Sustainable Energy Reviews, Elsevier, vol. 59(C), pages 1229-1245.
    3. Xu, Li & Deng, Shi-Jie & Thomas, Valerie M., 2016. "Carbon emission permit price volatility reduction through financial options," Energy Economics, Elsevier, vol. 53(C), pages 248-260.
    4. Eugenia Sanin, María & Violante, Francesco & Mansanet-Bataller, María, 2015. "Understanding volatility dynamics in the EU-ETS market," Energy Policy, Elsevier, vol. 82(C), pages 321-331.
    5. Julien Chevallier, 2013. "Carbon trading: past, present and future," Chapters, in: Roger Fouquet (ed.), Handbook on Energy and Climate Change, chapter 21, pages 471-489, Edward Elgar Publishing.
    6. Marc Gronwald & Janina Ketterer & Stefan Trück, 2011. "The Dependence Structure between Carbon Emission Allowances and Financial Markets - A Copula Analysis," CESifo Working Paper Series 3418, CESifo Group Munich.
    7. Viteva, Svetlana & Veld-Merkoulova, Yulia V. & Campbell, Kevin, 2014. "The forecasting accuracy of implied volatility from ECX carbon options," Energy Economics, Elsevier, vol. 45(C), pages 475-484.
    8. Andrea Petrella & Sandro Sapio, 2010. "No PUN intended: A time series analysis of the Italian day-ahead electricity prices," RSCAS Working Papers 2010/03, European University Institute.
    9. Ketterer, Janina C., 2014. "The impact of wind power generation on the electricity price in Germany," Energy Economics, Elsevier, vol. 44(C), pages 270-280.
    10. Fagiani, Riccardo & Hakvoort, Rudi, 2014. "The role of regulatory uncertainty in certificate markets: A case study of the Swedish/Norwegian market," Energy Policy, Elsevier, vol. 65(C), pages 608-618.
    11. Zhou, P. & Zhang, L. & Zhou, D.Q. & Xia, W.J., 2013. "Modeling economic performance of interprovincial CO2 emission reduction quota trading in China," Applied Energy, Elsevier, vol. 112(C), pages 1518-1528.
    12. Zhang, Yue-Jun & Peng, Yu-Lu & Ma, Chao-Qun & Shen, Bo, 2017. "Can environmental innovation facilitate carbon emissions reduction? Evidence from China," Energy Policy, Elsevier, vol. 100(C), pages 18-28.
    13. Chevallier, Julien, 2013. "Variance risk-premia in CO2 markets," Economic Modelling, Elsevier, vol. 31(C), pages 598-605.
    14. Tan, Xue-Ping & Wang, Xin-Yu, 2017. "Dependence changes between the carbon price and its fundamentals: A quantile regression approach," Applied Energy, Elsevier, vol. 190(C), pages 306-325.

    More about this item

    Keywords

    EU ETS; Option prices; Volatility; GARCH; Rolling estimation; Endogenous structural break detection;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • Q57 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Ecological Economics
    • Q58 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environmental Economics: Government Policy

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