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Allowance prices in the EU ETS -- fundamental price drivers and the recent upward trend

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  • Marina Friedrich
  • Michael Pahle

Abstract

In 2017 allowance prices in the EU Emissions Trading Scheme (ETS) have started to rally from persistently low levels in previous years. Market observers attribute this development to the ETS reform, naming anticipation of the tightening of allowance supply through the Market Stability Reserve (MSR) and speculative buying as main price drivers. The former suggests an increasing role of fundamentals, while the latter could give rise to investor overreaction and mispricing. Analyzing the price run up using the anticipative dating algorithm by Phillips et al. (2015), we obtain first empirical results that detect explosive behavior in prices from February 2018 on. Such behavior could reflect an adaption process, or be an indicator for market exuberance during the inflationary phase of a bubble. Testing for the former, we neither find that abatement-related fundamentals display equally explosive behavior, nor a change in coefficients using a complementary time-varying non-parametrical regression model. Finally, we examine the two potential explanations from a theoretical angle to shed light on candidate underlying mechanisms. We conclude that no explanation can be ruled out, but further research is needed to increase confidence in either.

Suggested Citation

  • Marina Friedrich & Michael Pahle, 2019. "Allowance prices in the EU ETS -- fundamental price drivers and the recent upward trend," Papers 1906.10572, arXiv.org, revised Nov 2019.
  • Handle: RePEc:arx:papers:1906.10572
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    References listed on IDEAS

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    Cited by:

    1. Edenhofer, Ottmar & Flachsland, Christian & Kalkuhl, Matthias & Knopf, Brigitte & Pahle, Michael, 2019. "Optionen für eine CO2-Preisreform," Working Papers 04/2019, German Council of Economic Experts / Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung.

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