Futures price dynamics of CO2 emission allowances

Abstract

We analyze the pricing and lead–lag relationship between spot and futures prices of CO2 emission allowances in the EU emission trading scheme. We show that the cost-of-carry hypothesis between spot and futures prices holds for the trial period. In this period we focus on how fast a deviation from equilibrium due to shocks is restored. We derive testable restrictions on the loading coefficients and the short term dynamics within a vector error correction model. Previous studies in this field did not take into account the effects of lagged differences in the determination of the speed of adjustment. The results indicate that deviations from equilibrium are restored faster for the futures price series maturing in 2006 than for the futures price series maturing in 2007. Furthermore, we conduct an impulse response analysis using local projections with conditional confidence bands. Finally, we give an outlook for the Kyoto commitment period which is already running. In this time period so far we find that the cost-of-carry hypothesis does not hold.