One of the main objectives of the European Union Emission Trading Scheme is the establishment of a market price level for allowances that show to European CO2 emitting installations the environmental impact of their polluting activities. The aim of this paper is to focus on the daily price changes during 2005 in an attempt to examine the underlying rationality of pricing behaviour. Specifically, we study the effect of those weather and non-weather variables that academic and market agents consider as the major determinants of the of CO2 price levels. The results show that the energy sources are the principal factors in the determination of CO2 price levels, and that only extreme temperatures influence them.

a b s t r a c tThe topic of this article is the analysis of the interplay between daily carbon, electricity and gas price data with the European Union Emission Trading System (EU ETS) for CO 2 emissions. In a first step we have performed Granger causality tests for Phase I of the EU ETS (January 2005 until December 2007) and the first year of Phase II of the EU ETS (2008). The analysis includes both spot and forward markets-given the close interactions between the two sets of markets. The results show that during Phase I coal and gas prices, through the clean dark and spark spread, impacted CO 2 futures prices, which in return Granger caused electricity prices. During the first year of the Phase II, the short-run rent capture theory (in which electricity prices Granger cause CO 2 prices) prevailed. On the basis of the qualitative results of the Granger causality tests we obtained the formulation testable equations for quantitative analysis. Standard OLS regressions yielded statistically robust and theoretically coherent results.

This article studies the price relationships between EU emissions allowances (EUAs)valid under the EU Emissions Trading Scheme (EU ETS)-and secondary Certified Emissions Reductions (sCERs)-established from primary CERs generated through the Kyoto Protocol's Clean Development Mechanism (CDM). Given the price differences between EUAs and sCERs, financial and industrial operators may benefit from arbitrage strategies by buying sCERs and selling EUAs (i.e. selling the EUA-sCER spread) to cover their compliance position between these two assets, as industrial operators are allowed to use sCERs towards compliance with their emissions cap within the European system up to 13.4%. Our central results show that the spread is mainly driven by EUA prices and market microstructure variables and less importantly, as we would expect, by emissions-related fundamental drivers. This might be justified by the fact that the EU ETS remains the greatest source of CER demand to date.

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We study the short-term price behavior of Phase 2 EU emission allowances. We model returns and volatility dynamics, and we demonstrate that a standard ARMAX-GARCH framework is inadequate for this modeling and that the gaussianity assumption is rejected due to a number of outliers. To improve the fitness of the model, we combine the underlying price process with an additive stochastic jump process. We improve the model's performance by introducing a time-varying jump probability that is explained by two variables: the daily relative change in the volume of transactions and the European Commission's announcements regarding the supply of permits. We show that (i) sharp increases in volume have led to increased volatility during the April 2005-December 2007period but not for the period beginning in January 2008, and (ii) announcements induce jumps in the process that tend to increase volatility across both periods. Thus, authorities face a trade off between disseminating information effectively and promoting market stability.