Improving Liquidity in Emission Trading Schemes

Forthcoming, Journal of Futures Markets

KAIST College of Business Working Paper Series No. 2021-008

Posted: 1 Jul 2021 Last revised: 28 Jul 2021

See all articles by Jihun Kim

Jihun Kim

Yonsei University - College of Government and Business

Kwangwoo Park

College of Business, Korea Advanced Institute of Science and Technology (KAIST)

Date Written: June 22, 2021

Abstract

This paper constructs a model of an Emission Trading Scheme (ETS) market using bid-ask spreads. We show that when such a market is dominated by a small number of traders with substantial market power, they tend to maximize their profits by widening bid-ask spreads, thereby reducing market liquidity. We argue that adding more market participants, including derivatives traders, can alleviate this illiquidity problem. Policy changes at the European Union’s ETS illustrate our theory, as the market significantly increased liquidity by enacting liquidity-provision policies to attract more participants as it transitioned from Phase 1 to Phase 2.

Keywords: EU ETS, market power, market activation, policy effectiveness

JEL Classification: G13, G14, H32, Q54, Q58

Suggested Citation

Kim, Jihun and Park, Kwangwoo, Improving Liquidity in Emission Trading Schemes (June 22, 2021). Forthcoming, Journal of Futures Markets, KAIST College of Business Working Paper Series No. 2021-008, Available at SSRN: https://ssrn.com/abstract=3876822

Jihun Kim

Yonsei University - College of Government and Business ( email )

Korea, Republic of (South Korea)

Kwangwoo Park (Contact Author)

College of Business, Korea Advanced Institute of Science and Technology (KAIST) ( email )

85 Hoegiro
Seoul 02455
Korea, Republic of (South Korea)
82-2-958-3540 (Phone)
82-2-958-3604 (Fax)

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