Price determination in the EU ETS market: Theory and econometric analysis with market fundamentals |
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| Affiliation: | 1. Government Institute for Economic Research, P.O. Box 1279, 00101 Helsinki, Finland;2. Department of Economics and Management, P.O. Box 27, FIN00014, University of Helsinki, Finland;3. Department of Forest Sciences, P.O. Box 27, FIN00014, University of Helsinki, Finland;1. Lebow College of Business, Drexel University, Philadelphia, PA 19104, United States;2. IPAG Business School, Paris, France;3. London School of Economics, LSE Alumni Association, Houghton Street, London WC2 2AE, United Kingdom;4. University of Minho, Department of Economics and Economic Policies Research Unit (NIPE), Campus of Gualtar, 4710-057-Braga, Portugal |
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| 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. |
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