The Timeline of Trading Frictions in the European Carbon Market

Abstract

During its trial phase (Phase I), the EU Greenhouse Gas Emission Trading Scheme (EU-ETS) collapsed because of an over-allocation of emission allowances. We evaluate the progress of this market from the trial phase to the next commitment period (Phase II) from a microstructure angle. We show that trading frictions, as measured by the relative spread, information-asymmetry risk, and market making profits decreased from Phase I to Phase II. Although volatility decreased, its noise-related component gained prominence over its information-related component, resulting in lower quality of the price changes.

Keywords: European Union Emission Trading Scheme; European Union Allowances; trading frictions; informativeness of prices; market quality; market microstructure

JEL Classification: G1