EU ETS Market Interactions: A Multiple Hypothesis Testing Approach

Abstract

As the European Union Emissions Trading Scheme (EU ETS) prepares for the post-2012 Phase III period that runs to 2020, a timely assessment of European Union Allowance (EUA) and Certified Emissions Reduction (CER) price interactions over the Phase II period is presented. Vector autoregression and Granger causality testing is employed for this analysis. The key contribution over existing literature is the application of sophisticated multiple hypothesis testing (MHT) procedures to control for the multiple comparisons problem, whereby under naive analysis the identification of significant results may occur by pure chance alone. Both generalisd familywise error rate and false discovery proportion procedures are used to control for this problem. Over the latter part of Phase II, the generalisd familywise error rate procedures show evidence of term structure interactions within the EUA and CER forward curves. Interactions between the EUA and CER markets are also shown to exist. However, a word of caution is sounded as the false discovery proportion procedures fail to confirm any such interactions. This comparison of alternative MHT procedures in the one empirical study provides important insights for researchers.