Carbon markets in times of VUCA: a weak-form efficiency investigation of the phase II EU ETS

Abstract

We examine the weak-form efficiency status of the European carbon market over periods of sustained volatility, uncertainty, complexity and ambiguity. We use 1,035 daily spot price data observations from the Phase II European Union Emissions Trading Scheme from 2008 to 2012, along with random walk and trading rule profitability tests. To establish the evolution of weak-form efficiency, the time period under investigation is further divided into two distinct crisis periods, i.e. global financial crisis (GFC) period and European sovereign debt crisis (ESDC) period. Period 1 random walk test findings provide limited support for price return predictability in the European carbon market during the GFC. Period 2 results show that price return predictabilities became non-existent during the ESDC. Trading rule profitability findings reveal that after applying simple trading rules (that account for risk and transaction costs), price return predictabilities cannot be manipulated to profit above a naive buy-and-hold strategy in the European carbon market. Despite ongoing market volatility, economic uncertainty and complexity, and global climate change policy ambiguity, it appears that the EU ETS is becoming more weak-form efficient.

Keywords:

• capital markets
• socially responsible investment
• sustainability

Notes

The GFC and ESDC are considered to be among the most destructive and controversial crisis events since the Great Depression.

The GFC (or sub-prime crisis, global credit crisis, liquidity crisis, etc.) was primarily caused by both the securitisation of the US mortgage market, i.e. bundling of sub-prime mortgages into derivatives and synthetic products, and excessive financial leverage and risk taking.

Phase II of the EU ETS runs from February 2008 to December 2012.

BlueNext is a European environmental trading exchange and was founded by NYSE EuroNext and Caisse des Depots in December 2007. Spot and derivative products (including EUAs) are traded on the exchange. A historical price database is freely available and can be accessed at www.bluenext.eu/statistics/downloads.php.