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The relationship between spot and futures CO2 emission allowance prices in the EU-ETS

Author

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  • Stefan Trück
  • Wolfgang Härdle
  • Rafal Weron

Abstract

In this paper we investigate the relationship between spot and futures prices within the EU-wide CO2 emissions trading scheme (EU-ETS). We conduct an empirical study on price behavior, volatility term structure and correlations in different CO2 EU Allowance (EUA) contracts during the pilot trading and Kyoto commitment periods. We find that while for the pilot trading period (2005-2007) the market was initially in backwardation, after the news of overallocation, both allowance prices and convenience yield approached zero. During the Kyoto commitment period (2008-2012), the market has changed from initial backwardation to contango with significant convenience yields in futures contracts. We further examine the dynamic structure of the relationship between spot and futures prices in the functional form by applying a new approach of dynamic semiparametric factor models (DSFM). Interestingly, our DSFM results can be related to the classic Gibson-Schwartz two-factor model for pricing contingent claims in commodity markets that uses the spot price and the instantaneous convenience yield as factors. Our results might point towards future applications of the Gibson-Schwartz model for pricing of intra- and inter-period EUA derivatives contracts.

Suggested Citation

  • Stefan Trück & Wolfgang Härdle & Rafal Weron, 2012. "The relationship between spot and futures CO2 emission allowance prices in the EU-ETS," HSC Research Reports HSC/12/02, Hugo Steinhaus Center, Wroclaw University of Science and Technology.
    • Handle: RePEc:wuu:wpaper:hsc1202
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    References listed on IDEAS

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    4. Stefan Trück & Rafał Weron, 2016. "Convenience Yields and Risk Premiums in the EU‐ETS—Evidence from the Kyoto Commitment Period," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 36(6), pages 587-611, June.
    5. Benschopa, Thijs & López Cabreraa, Brenda, 2014. "Volatility modelling of CO2 emission allowance spot prices with regime-switching GARCH models," SFB 649 Discussion Papers 2014-050, Humboldt University Berlin, Collaborative Research Center 649: Economic Risk.
    6. Koop, Gary & Tole, Lise, 2013. "Modeling the relationship between European carbon permits and certified emission reductions," Journal of Empirical Finance, Elsevier, vol. 24(C), pages 166-181.
    7. Gil-Alana, Luis A. & Gupta, Rangan & de Gracia, Fernando Perez, 2016. "Modeling persistence of carbon emission allowance prices," Renewable and Sustainable Energy Reviews, Elsevier, vol. 55(C), pages 221-226.
    8. Shawkat Hammoudeh & Duc Khuong Nguyen & Ricardo M. Sousa, 2014. "What explains the short," Working Papers 2014-81, Department of Research, Ipag Business School.
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    10. Don Bredin and John Parsons, 2016. "Why is Spot Carbon so Cheap and Future Carbon so Dear? The Term Structure of Carbon Prices," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3).
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    12. Hammoudeh, Shawkat & Nguyen, Duc Khuong & Sousa, Ricardo M., 2014. "What explain the short-term dynamics of the prices of CO2 emissions?," Energy Economics, Elsevier, vol. 46(C), pages 122-135.
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    More about this item

    Keywords

    CO2 Emission Trading; Commodity Markets; Spot and Futures Prices; Convenience Yields; Dynamic Semiparametric Factor Model (DSFM); Gibson-Schwartz model;
    All these keywords.

    JEL classification:

    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q28 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Government Policy

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