European emission allowance and equity markets: evidence from further trading phases

Abstract

Purpose This paper aims to investigate the value relevance of the European Emission Allowance (EUA) return and volatility on the equity value of the top listed European Power Generation Firms for the three trading phases of the European Emission Trading Scheme. Design/methodology/approach The authors use the multifactor financial market model over the period 2005-2016 on daily basis for the return relevance relationship, whereas time series models such as autoregression moving average and generalized autoregressive conditional heteroskedasticity are applied on a weighted average portfolio of the sample firms to test serial correlation and volatility of returns. Findings The findings are novel in which a positive and significant relevance of EUA return on equity return is shown; however, a vanishing effect is seen as one moves to further trading phases. Another remarkable finding is that the return relationship remains constant until a certain level in EUA price then inverts. Finally, the authors present that EUA is considered a systematic factor as firm and country-specific features are not statistically significant. Practical implications At policy level, these findings signal policymakers for an appropriate design of the future trading phases in which they achieve the balance between public interests, as climate risk mitigation by reducing emissions, and the private interests of the market players to support innovative changes. Originality/value To the authors’ knowledge, this study would be the first to offer recent and comprehensive findings on the economic and financial implications of the European Emission Trading Scheme for the three trading phases. Additionally, the research offers time series robustness check besides the standard regression analysis and shows that there is an optimal EUA price that triggers polluters’ decision on emission and generation.

Carbon Emissions Announcements and Market Returns

“…The ETS scheme has room for further tightening as technology improves. [2] focus on energy firms, finding that profits can still be made during tightening, although highly polluting firms' profits are more susceptible to emissions regulations. If this finding applies to other industries, there is a good case for all firms to work towards being less polluting to protect their profits.…”

“…However, if companies differ significantly in size (or when it comes to the largest companies), environment-minded investors would care less about the relative contribution and more about the total amount of emissions (measure by logs). Therefore, a natural logarithm is taken as a robustness test to make the coefficients more interpretable [2,3]. The variables that are transformed this way are therefore netcarbon, carbon1, carbon2, and carbon3.…”

“…Therefore, there is a growing need to understand the relationship between emissions and stock returns. If no relationship exists, then the funds and stocks that are known to provide a safe return [2] would be chosen, but at the cost of the environment. Oil, gas, and heavy industry stocks have long fallen into this grouping and remain important investments today for several investors.…”

Has the EU-ETS Financed the Energy Transition of the Italian Power System?

“…Power producers can use the allowances they own either to sell them to other market participants or to cover the greenhouse gas emissions resulting from their power production. Allowances are, therefore, financial products, exchanged in financial markets (Cludius and Betz 2020;Daskalakis et al 2009;Graham et al 2016;Harasheh and Amaduzzi 2019). By using the allowances to produce electricity, one bares the opportunity cost of losing their financial value.…”