Politics Matters: Regulatory Events as Catalysts for Price Formation Under Cap-and-Trade

44 Pages Posted: 9 May 2015

See all articles by Nicolas Koch

Nicolas Koch

Mercator Research Institute on Global Commons and Climate Change (MCC); University of Hamburg

Godefroy Grosjean

Potsdam-Institut für Klimafolgenforschung (PIK)

Sabine Fuss

Mercator Research Institute on Global Commons and Climate Change (MCC); International Institute for Applied Systems Analysis (IIASA)

Ottmar Edenhofer

Potsdam Institute for Climate Impact Research (PIK); Mercator Research Institute on Global Commons and Climate Change (MCC); Technische Universität Berlin (TU Berlin)

Date Written: May 6, 2015

Abstract

This paper investigates whether and how allowance prices respond to regulatory news in the world's largest cap-and-trade system - the EU ETS. Capitalizing on an event study method that incorporates an econometric technique designed to handle parameter instability and model uncertainty, we assess the news-implied price response to 29 hand-collected announcements about the EU ETS supply schedule between 2008 and 2014. Our findings document a high responsiveness of the cap-and-trade market to political events and reveal how market participants view the evolution of cap stringency in the light of a particular announcement. We provide strong evidence that backloading caused substantial price declines. The latter evolve gradually as market confidence in the political support for backloading and a stringent EU ETS is shaken in the lengthy legislative process. We also document positive price reactions to the 2020 and 2030 policy packages, but not the 2050 roadmaps.

Keywords: cap-and-trade, EU ETS, allowance supply, political uncertainty, event study, Bayesian

JEL Classification: C11, C53, G14, Q52, Q54, Q58

Suggested Citation

Koch, Nicolas and Grosjean, Godefroy and Fuss, Sabine and Edenhofer, Ottmar, Politics Matters: Regulatory Events as Catalysts for Price Formation Under Cap-and-Trade (May 6, 2015). Available at SSRN: https://ssrn.com/abstract=2603115 or http://dx.doi.org/10.2139/ssrn.2603115

Nicolas Koch (Contact Author)

Mercator Research Institute on Global Commons and Climate Change (MCC) ( email )

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University of Hamburg ( email )

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Godefroy Grosjean

Potsdam-Institut für Klimafolgenforschung (PIK) ( email )

Telegrafenberg 31
Potsdam, Brandenburg 14473
Germany

Sabine Fuss

Mercator Research Institute on Global Commons and Climate Change (MCC) ( email )

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Berlin, 10829
Germany
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International Institute for Applied Systems Analysis (IIASA) ( email )

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HOME PAGE: http://www.iiasa.ac.at

Ottmar Edenhofer

Potsdam Institute for Climate Impact Research (PIK) ( email )

P.O. Box 601203
14412 Potsdam, Brandenburg
Germany

Mercator Research Institute on Global Commons and Climate Change (MCC)

Torgauer Straße 12-15
Berlin, 10829
Germany

Technische Universität Berlin (TU Berlin)

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Berlin, 10623
Germany

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