The Market Microstructure of the European Climate Exchange

Abstract:     
This paper analyzes the market microstructure of the European Climate Exchange, the largest EU ETS trading venue. The ECX captures 2/3 of the screen traded market in EUA and more than 90% in CER. 2009 Trading volumes total €22 billion and are growing, with EUA transactions doubling, and CER volume up 61%. Spreads range from €0.02 to €0.04 for EUA and €0.04 for actively traded CER. Market impact estimates imply that an average trade will move the EUA market by 1.06 euro centimes and the CER market 1.45. The proportion of the EUA spread due to adverse selection reaches 76%. Our findings of highly autocorrelated trade direction and short time interval between trades imply evidence of strategic trading by informed institutional traders. Both Granger-Gonzalo and Hasbrouck information shares imply that approximately 90% of price discovery is taking place in the ECX EUA futures market compared to the BlueNext spot market. The information dominance of CER futures to spot is not as strong as EUA. We find imbalances in the order book help predict returns for up to three days. A simple trading strategy that enters the market long or short when the order imbalance is strong is profitable even after accounting for spreads and market impact.

Number of Pages in PDF File: 42

Keywords: carbon trading, market microstructure, bid-ask spread, market impact, information shares, order book imbalance

JEL Classification: G13, G32, E44

working papers series