Price formation in the EU carbon market

Résumé

A key argument in favor of emissions markets (relative to command-and-control types of regulation) is their ability to aggregate dispersed information about abatement costs and emissions and generate price signals to guide firms' trading and abatement decisions. We exploit recently released trading data from the first phase of the EU emissions trading scheme (EU ETS) to assess the extent to which this market was indeed able to deliver such price signals. We know who traded, when, with whom, on which platform if any, and at what price. Participation was partial, trading patterns differed across categories of market participants and the market was fragmented. We build a model of trading and information aggregation that integrates the salient features of the market and use it to explore their impact on the price formation process. Risk management and partial participation help account for some of the price anomalies that have been identified in the past on the basis of the analysis of price time series only. (joint with Aurélie Slechten)