This paper investigates price formation in the European Union Emissions Trading Scheme (EU ETS). The aim of the paper is to know what is happening to the European Union Allowance (EUA) price, when new information hits the EU ETS. The focus lies on EUA prices reactions to the European Commission's decisions (the EC's decisions) on second National Allocation Plans (NAPs). Since prices should react only to unexpected information, a model of expectation-formation is provided, where agents anticipate the EC's decision on second NAPs. An empirical analysis supports the model; unexpected allocations of emissions allowances leads to pronounced price reactions of the expected signs. Moreover, the adjustment is not instantaneous, but takes up to six hours after the decision announcement. The obtained results allow following conclusions. Our regression model is able to explain the EUA price reactions immediately after the publication of the EC's decision on second NAPs. In particular, EUA prices adjust in the expected direction as a simple economic model of supply and demand would suggest. Hence, there is no evidence that EUA prices are disconnected from the considered fundamental factor, namely the overall supply of EUAs in the second commitment period. However, the slow adjustment of EUA prices to new information suggests that the EU ETS is not fully informationally efficient regarding the determination of the size of the overall cap.
Rotfuß, Waldemar, Christian Conrad and Daniel Rittler (2009), The European Commission and EUA Prices: A High-Frequency Analysis of the EC's Decisions on Second NAPs, ZEW Discussion Paper No. 09-045, Mannheim. Download