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On the realized volatility of the ECX CO 2 emissions 2008 futures contract: distribution, dynamics and forecasting

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Listed author(s):
  • Julien Chevallier

    ()

  • Benoît Sévi

    ()

Abstract

The recent implementation of the EU Emissions Trading Scheme (EU ETS) in January 2005 created new financial risks for emitting firms. To deal with these risks, options are traded since October 2006. Because the EU ETS is a new market, the relevant underlying model for option pricing is still a controversial issue. This article improves our understanding of this issue by characterizing the conditional and unconditional distributions of the realized volatility for the 2008 futures contract in the European Climate Exchange (ECX), which is valid during Phase II (2008-2012) of the EU ETS. The realized volatility measures from naive, kernel-based and subsampling estimators are used to obtain inferences about the distributional and dynamic properties of the ECX emissions futures volatility. The distribution of the daily realized volatility in logarithmic form is shown to be close to normal. The mixture-of-distributions hypothesis is strongly rejected, as the returns standardized using daily measures of volatility clearly departs from normality. A simplified HAR-RV model (Corsi, 2009) with only a weekly component, which reproduces long memory properties of the series, is then used to model the volatility dynamics. Finally, the predictive accuracy of the HAR-RV model is tested against GARCH specifications using one-step-ahead forecasts, which confirms the HAR-RV superior ability. Our conclusions indicate that (i) the standard Brownian motion is not an adequate tool for option pricing in the EU ETS, and (ii) a jump component should be included in the stochastic process to price options, thus providing more efficient tools for risk-management activities.

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File URL: http://hdl.handle.net/10.1007/s10436-009-0142-x
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Article provided by Springer in its journal Annals of Finance.

Volume (Year): 7 (2011)
Issue (Month): 1 (February)
Pages: 1-29

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Handle: RePEc:kap:annfin:v:7:y:2011:i:1:p:1-29
DOI: 10.1007/s10436-009-0142-x
Contact details of provider: Web page: http://www.springer.com

Order Information: Web: http://www.springer.com/finance/journal/10436/PS2

Keywords: CO 2 price; Realized volatility; HAR-RV; Emissions markets; EU ETS; Intraday data; Forecasting; C5; G1; Q4;

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Find related papers by JEL classification:
  • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
  • G1 - Financial Economics - - General Financial Markets
  • Q4 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy

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Cited by:

  1. Julien Chevallier, 2010. "Modelling the convenience yield in carbon prices using daily and realized measures," Working Papers halshs-00463921, HAL.
  2. 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).
  3. Rittler, Daniel, 2012. "Price discovery and volatility spillovers in the European Union emissions trading scheme: A high-frequency analysis," Journal of Banking & Finance, Elsevier, vol. 36(3), pages 774-785.
  4. Chevallier, Julien, 2013. "Variance risk-premia in CO2 markets," Economic Modelling, Elsevier, vol. 31(C), pages 598-605.
  5. 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.
  6. Reckling, Dennis, 2016. "Variance risk premia in CO2 markets: A political perspective," Energy Policy, Elsevier, vol. 94(C), pages 345-354.
  7. Chevallier, Julien, 2011. "Nonparametric modeling of carbon prices," Energy Economics, Elsevier, vol. 33(6), pages 1267-1282.
  8. Segnon, Mawuli & Lux, Thomas & Gupta, Rangan, 2017. "Modeling and forecasting the volatility of carbon dioxide emission allowance prices: A review and comparison of modern volatility models," Renewable and Sustainable Energy Reviews, Elsevier, vol. 69(C), pages 692-704.
  9. Rittler, Daniel, 2009. "Price Discovery, Causality and Volatility Spillovers in European Union Allowances Phase II: A High Frequency Analysis," Working Papers 0492, University of Heidelberg, Department of Economics.

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