Modeling the relationship between European carbon permits and certified emission reductions

Gary Koop, Lise Tole

Research output: Contribution to journalArticle

11 Citations (Scopus)
26 Downloads (Pure)

Abstract

Recent years have seen an expansion of carbon markets around
the world as various policymakers attempt to reduce CO2 emissions. This paper
considers two of the major types of carbon permits: European Union Allowances
(EUAs, arising from the European Union Emissions Trading Scheme, EU ETS)
and certi…ed emissions reductions (CERs, arising from agreements made under
the Kyoto Protocol). The rules of the EU ETS allow for some use of CERs in
place of EUAs by EU …rms, but this substitutability is only partial. Allowing
for carbon permits from di¤erent sources to substitute for one another should
help achieve CO2 emissions reductions at least cost. Understanding the degree
and nature of linkages (if any) between the markets for EUAs and CER is,
thus, an important policy issue. In this paper, we jointly model the spot and
future prices of an EUA along with the price of a CER using ‡exible multi-
variate time series methods which allow for time-variation in parameters. We
…nd evidence of contemporaneous causality between these three variables with
the EUA futures price playing the dominant role in driving this relationship.
We also document time-variation in this relationship which is associated with
macroeconomic events such as the …nancial crisis of late 2008 and early 2009.
We …nd very little evidence of volatility spillovers or of Granger causality among
any of the variables. We discuss how these empirical …ndings are consistent with
markets which are loosely linked, but are not tightly linked as would be found
for perfectly substitutable assets in e¢ cient …nancial markets.
Original languageEnglish
Pages (from-to)166–181
Number of pages16
JournalJournal of Empirical Finance
Volume24
Early online date29 Oct 2013
DOIs
Publication statusPublished - 2013

Keywords

  • modeling
  • europe
  • european carbon permits
  • certified emission reductions
  • time-varying parameter VAR
  • stochastic volatility
  • carbon trading
  • spot and futures markets

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