Price Behavior And Market Efficiency Of European Union Emission Trading Market

Cap-and-Trade emission trading system introduces market mechanism and economic measures into reducing greenhouse gas emission and coping with climate change, and is paid more and more attention by many countries in their environmental policies. The European Union started cap-and-trade emission trading in 2005 and has initiated a market of European Union Allowance (EUA) which is dominant in global emission trading market. This dissertation studies the price behavior and market efficiency of European Union Allowance market, analyzes the volatility and influencing factors of EUA prices and its market efficiency and finally summarizes the experience and lessons which can be learned by China when it starts its domestic emission trading system.This dissertation first reviews the process of initiation, decision-making and implementation of European Union Emission Trading System (EU ETS), with the emphasis on the operating rules of the system and its current situation, which is the foundation of understanding the EUA market. Then, using time series techniques, the dissertation investigates the volatility and influencing factors of EUA prices and its market efficiency. Firstly, the results from GARCH modeling on price volatility and multiple variance ratio tests on information efficiency suggest that the adjustment in April 2006 is the milestone of EUA market development. April 2006 was the first time when the firms regulated by EU ETS uncovered their emission trading in 2005 and it turned out the allowances were over-allocated in 2005. This brought a dramatic drop to EUA price and the market witnessed a significant adjustment. After April 2006, the market volume had increased a lot and the traders were more diversified. This led to increased information efficiency as well as asymmetric responses in price volatility to positive and negative shocks. Secondly, the global financial crisis in 2008 has also changed the pattern of EUA market. EUA market slumped during the crisis and is more sensitive to stock market in the post-crisis period. Third, from its first phase to the second phase, EUA market has significantly developed in market efficiency and price discovery mechanism. In Phaseâ…¡, information efficiency are improved and the spot market dominates the price discovery instead of futures market, indicating that the market fundamentals plays more important roles in price formation and the market is more rational. Fourth, the results from Dynamic Conditional Correlation shows that the correlations of EUA market with financial market and commodity market are very weak and get even weaker when prices are more volatile, which suggests that EUA could be used by investors for portfolio diversification. Fifth, the results from cointergration test and vector error correction model shows that there is a long-term equilibrium between EUA market and electricity market and the latter is significantly impacted by the former. Moreover, profits of power plants and switching price from coal to gas significantly influence EUA price. These findings indicate that EUA market interacts with energy market and will play more and more important roles in global economy.Based on the analysis of the operating rules of EU ETS and their impact on EUA price, this dissertation summarizes four types of rules that significantly influence a cap-and-trade emission trading system:the amount of the allowances and the allocation method, the validity of the allowance during different phases, the completeness of the infrastructures for allowance trading and the certainty on the future of the system. In addition, since the implementation of EU ETS, the emission reduction rates in EU 15 and EU 27 are accelerated. According to the average annual emission reduction rates during 2005 and 2009, EU will successfully achieve its target in Kyoto Protocol. The establishment of emission trading system and the development of allowance market endow emission right with value and turn it into property, therefore enhancing the awareness of emission reduction among polluters. The establishment and development of emission trading market not only set a price for emission right, but also forms the expectation among firms and individuals that the emission right will be more and more valuable in the future.The analysis on EU ETS in this dissertation is aimed to promote deeper understanding on emission trading and provide reference for China to establish its emission trading system. Therefore, this dissertation concludes with a summary of the experience and lessons which can be learned from EU ETS and are helpful for China.