Real Effects of Carbon Financialization

83 Pages Posted: 16 May 2024

See all articles by Zhimin Chen

Zhimin Chen

Swiss Finance Institute and University of Lausanne

Date Written: April 29, 2024


The recent influx of financial traders into carbon allowance markets has raised concerns about its distortive effects on carbon allowance prices and its repercussions for firms that rely on these price signals to make emissions decisions. This paper studies how financial carbon trading affects the allocative efficiency of carbon allowance markets and highlights the importance of facilitating financial arbitrages rather than imposing restrictions. Exploiting allowance transaction data in the European carbon market and using carbon policy shocks as supply shifters, I identify a price-inelastic carbon demand by large financial traders. The lack of elastic arbitrage capital is associated with a decline in the carbon price informativeness and contributes to the carbon market crash during the Russia-Ukraine war. The decreased informativeness has real effects: I find that firms with inferior private information reduce their emissions less efficiently when the carbon price is less informative, and the cross-sectional dispersion of carbon intensity increases with the informational inefficiency. I develop a macro-finance model with managerial learning from carbon prices that rationalizes these novel empirical findings.

Keywords: Cap-and-trade, carbon financialization, limits to arbitrage, price informativeness, managerial learning, carbon misallocation

JEL Classification: G14, O11, Q54

Suggested Citation

Chen, Zhimin, Real Effects of Carbon Financialization (April 29, 2024). Available at SSRN: or

Zhimin Chen (Contact Author)

Swiss Finance Institute and University of Lausanne ( email )

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4

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