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A model of carbon price interactions with macroeconomic and energy dynamics

  • Chevallier, Julien

his paper develops a model of carbon pricing by considering two fundamental drivers of European Union Allowances : economic activity and energy prices. On the one hand, economic activity is proxied by aggregated industrial production in the EU 27 (as it provides the best performance in a preliminary forecasting exercise vs. other indicators). On the other hand, brent, natural gas and coal prices are selected as being the main carbon price drivers (as highlighted by previous literature). The interactions between the macroeconomic and energy spheres are captured in a Markov-switching VAR model with two states that is able to reproduce the ‘boom–bust’ business cycle (Hamilton (1989)). First, industrial production is found to impact positively (negatively) the carbon market during periods of economic expansion (recession), thereby confirming the existence of a link between the macroeconomy and the price of carbon. Second, the brent price is confirmed to be the leader in price formation among energy markets (Bachmeier and Griffin (2006)), as it impacts other variables through the structure of the Markov-switching model. Taken together, these results uncover new interactions between the recently created EU emissions market and the pre-existing macroeconomic/energy environment.

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Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/6969.

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Date of creation: Nov 2011
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Publication status: Published in Energy Economics, 2011, Vol. 33, no. 6
Handle: RePEc:dau:papers:123456789/6969
Contact details of provider: Web page: http://www.dauphine.fr/en/welcome.html
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