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Price determination in the EU ETS market: Theory and econometric analysis with market fundamentals

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  • Aatola, Piia
  • Ollikainen, Markku
  • Toppinen, Anne

Abstract

We investigate the price determination of the European Union emission allowance (EUA) of the European Union emissions trading scheme (EU ETS). We postulate an uncertain permit price and risk-averse firms which have the possibility to hedge in the forward market. The firms produce final goods, abate their emissions and trade permits in the permit market. The dependence of the equilibrium permit price on exogenous variables is studied in a permit market model. We test our theoretical findings with empirical data from 2005 to 2010 in the EU ETS market. We use daily forward prices of EUA as our dependent variable. We use several econometric models with multiple stationary time series to discover that there is a strong relationship between the fundamentals, such as German electricity prices and gas and coal prices, with the price of EUA. We find that the EUA forward price depends on fundamentals, especially on the price of electricity as well as on the gas–coal difference, in a statistically significant way.

Suggested Citation

  • Aatola, Piia & Ollikainen, Markku & Toppinen, Anne, 2013. "Price determination in the EU ETS market: Theory and econometric analysis with market fundamentals," Energy Economics, Elsevier, vol. 36(C), pages 380-395.
    • Handle: RePEc:eee:eneeco:v:36:y:2013:i:c:p:380-395
    DOI: 10.1016/j.eneco.2012.09.009
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    More about this item

    Keywords

    European Union emissions trading; Permit price; Risk; Econometric analysis;
    All these keywords.

    JEL classification:

    • Q52 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Pollution Control Adoption and Costs; Distributional Effects; Employment Effects
    • Q53 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Air Pollution; Water Pollution; Noise; Hazardous Waste; Solid Waste; Recycling

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