Abstract
The aim of the European Union's Emissions Trading Scheme is that by 2020, emissions from sectors covered by the EU ETS will be 21% lower than in 2005. In addition to large CO$_2$ emitting companies covered by the scheme, other participants have entered the market with a view to using emission allowances for the diversification of their investment portfolios. The performance of this asset as a stand alone investment, as well as its portfolio diversification implications will be investigated in this paper. Our results indicate that the market views Phase 1, Phase 2 and Phase 3 EUA futures as unattractive as stand alone investments. In a portfolio context, in Phase 1, once the short-selling option is added, there are considerable portfolio benefits. However, our results indicate that these benefits only existed briefly during the pilot stage of the EU ETS. There is no evidence to suggest portfolio diversification benefits exist for Phase 2 or the early stages of Phase 3.
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