Trading Costs for Futures in the European Union Emissions Trading Scheme

Abstract

This paper is the first empirical study to focus on the role of liquidity for futures in the European Union Emissions Trading Scheme (EU-ETS). In this large and fast growing market with a global market value of $50 billion, liquidity is fundamental because it enables entities to trade quickly with small price impacts and meet their compliance obligations at minimum cost. We encapsulate liquidity by introducing a transaction cost parameter which is proportional to trading volume in a risk factor model based on the Capital Asset Pricing Model, in the futures markets in Phase I (2005-2007) of the EU-ETS. Our results show that trading costs are insignificant suggesting that the EU-ETS futures market is liquid. We believe that our findings could be due to an over supply of emission allowances in Phase I of the scheme, resulting in low proportional trading costs due to a reduction in trading volume.