On the Realized Volatility of the ECX CO2 Emissions 2008 Futures Contract: Distribution, Dynamics and Forecasting

34 Pages Posted: 13 May 2009 Last revised: 17 Jan 2017

See all articles by Julien Chevallier

Julien Chevallier

University of Paris 8 Vincennes-Saint Denis

Benoît Sévi

University of Nantes

Date Written: May 12, 2009

Abstract

The recent implementation of the EU Emissions Trading Scheme (EU ETS) in January 2005 created new financial risks for emitting firms. To deal with these risks, options are traded since October 2006. Because the EU ETS is a new market, the relevant underlying model for option pricing is still a controversial issue. This article improves our understanding of this issue by characterizing the conditional and unconditional distributions of the realized volatility for the 2008 futures contract in the European Climate Exchange (ECX), which is valid during Phase II (2008-2012) of the EU ETS. The realized volatility measures from naive, kernel-based and subsampling estimators are used to obtain inferences about the distributional and dynamic properties of the ECX emissions futures volatility. The distribution of the daily realized volatility in logarithmic form is shown to be close to normal. The mixture-of-distributions hypothesis is strongly rejected, as the returns standardized using daily measures of volatility clearly departs from normality. A simplified HAR-RV model (Corsi, 2009) with only a weekly component, which reproduces long memory properties of the series, is then used to model the volatility dynamics. Finally, the predictive accuracy of the HAR-RV model is tested against GARCH specifications using one-step-ahead forecasts, which confirms the HAR-RV superior ability. Our conclusions indicate that (i) the standard Brownian motion is not an adequate tool for option pricing in the EU ETS, and (ii) a jump component should be included in the stochastic process to price options, thus providing more efficient tools for risk-management activities.

Keywords: CO2 Price, Realized Volatility, HAR-RV, GARCH, Futures Trading, Emissions Markets, EU ETS, Intraday Data, Forecasting

JEL Classification: C5, G1, Q4

Suggested Citation

Chevallier, Julien and Sévi, Benoît, On the Realized Volatility of the ECX CO2 Emissions 2008 Futures Contract: Distribution, Dynamics and Forecasting (May 12, 2009). FEEM Working Paper No. 113.2009, Available at SSRN: https://ssrn.com/abstract=1403419 or http://dx.doi.org/10.2139/ssrn.1403419

Julien Chevallier

University of Paris 8 Vincennes-Saint Denis ( email )

Paris
France

Benoît Sévi (Contact Author)

University of Nantes ( email )

1, quai de Tourville BP
Nantes Cedex 1
Nantes, 44313
France

HOME PAGE: http://www.iemniae.univ-nantes.fr/sevi-b/0/fiche___annuaireksup/

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