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The timeline of trading fricions in the European Carbon Market

  • Vicente Medina Martínez

    ()

    (Facultad de Economía)

  • Ángel Pardo Tornero

    (Dpto. Economía Financiera y Actuarial)

  • Roberto Pascual

    (Universitat de les Illes Balears)

We evaluate the quality of prices of the EU-ETS, the most active European derivative market for greenhouse gas emissions allowances (EUAs). So far, this market has had two phases, a trial phase (from 2005 to 2007) and a commitment phase (from 2008 to 2012). The true value of a trial-phase EUA at the beginning of 2008 was inevitably zero because it could not be used in the commitment phase to cover emission targets. However, continued rumors of over-allocation of EUAs led to an early collapse of the market by May 2007. We study whether this market breakdown and the subsequent outbreak of the international financial crisis had a persistent effect on the quality of the commitment phase. We provide robust evidence of substantial improvements in terms of liquidity, adverse selection costs, and friction-related volatility from the trial phase to the commitment phase. However, price quality (the proportion of friction-unrelated price return volatility) during the commitment phase has been below the levels achieved before the 2007 collapse. Our findings suggest that the carbon market has not fully recovered from the negative effects of its 2007 breakdown and the subsequent financial crisis.

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Paper provided by Instituto Valenciano de Investigaciones Económicas, S.A. (Ivie) in its series Working Papers. Serie AD with number 2012-05.

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Length: 43 pages
Date of creation: Feb 2012
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Publication status: Published by Ivie
Handle: RePEc:ivi:wpasad:2012-05
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