In 2017 allowance prices in the EU Emissions Trading Scheme ( ETS) have started to rally from persistently low levels in previous years. Market observers attribute this development to the ETS reform , naming anticipation of the tightening of allowance supply through the Market Stability Reserve (MSR) and speculative buying as main price drivers. The former suggests an increasing role of fundamentals, while the latter could give rise to investor overreaction and mispricing. Analyzing the price run up using the anticipative dating algorithm by Phillips et al. (2015), we obtain first empirical results that detect explosive behavior in prices from February 2018 on. Such behavior could reflect an adaption process, or be an indicator for market exuberance during the inflationary phase of a bubble. Testing for the former, we neither find that abatement-related fundamentals display equally explosive behavior, nor a change in coefficients using a complementary time-varying non-parametrical regression model. Finally, we examine the two potential explanations from a theoretical angle to shed light on candidate underlying mechanisms. We conclude that no explanation can be ruled out, but further research is needed to increase confidence in either .
In 2018, allowance prices in the EU Emission Trading Scheme ( EU ETS) experienced a run-up from persistently low levels in previous years. Regulators attribute this to a comprehensive reform in the same year, and are confident the new price level reflects an anticipated tighter supply of allowances. We ask if this is indeed the case, or if it is an overreaction of the market driven by speculation. We combine several econometric methods - time-varying coefficient regression, formal bubble detection as well as time stamping and crash odds prediction - to juxtapose the regulators' claim versus the concurrent explanation. We find evidence of a long period of explosive behaviour in allowance prices, starting in March 2018 when the reform was adopted. Our results suggest that the reform triggered market participants into speculation, and question regulators' confidence in its long-term outcome. This has implications for both the further development of the EU ETS, and the long lasting debate about taxes versus emission trading schemes .
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2017
2018,
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Emissions
Emission
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ETS) have started to rally
EU ETS) experienced a run-up
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Market observers attribute this development to the ETS reform , naming anticipation of the tightening of allowance supply through the Market Stability Reserve (MSR) and speculative buying as main price drivers. The former suggests an increasing role of fundamentals, while the latter could give rise to investor overreaction and mispricing. Analyzing the price run up using the anticipative dating algorithm by Phillips et al. (2015), we obtain first empirical results that detect explosive behavior in prices from February 2018 on. Such behavior could reflect an adaption process, or be an indicator for market exuberance during the inflationary phase of a bubble. Testing for the former, we neither find that abatement-related fundamentals display equally explosive behavior, nor a change in coefficients using a complementary
Regulators attribute this to a comprehensive reform in the same year, and are confident the new price level reflects an anticipated tighter supply of allowances. We ask if this is indeed the case, or if it is an overreaction of the market driven by speculation. We combine several econometric methods -
R
non-parametrical regression model. Finally, we examine the two potential explanations from a theoretical angle to shed light on candidate underlying mechanisms. We conclude that no explanation can be ruled out, but further research is needed to increase confidence in either
coefficient regression, formal bubble detection as well as time stamping and crash odds prediction - to juxtapose the regulators' claim versus the concurrent explanation. We find evidence of a long period of explosive behaviour in allowance prices, starting in March 2018 when the reform was adopted. Our results suggest that the reform triggered market participants into speculation, and question regulators' confidence in its long-term outcome. This has implications for both the further development of the EU ETS, and the long lasting debate about taxes versus emission trading schemes