Trading patterns in the European Carbon Market: the role of trading intensity and OTC transactions

International audienceThis paper examines the effect of trading intensity and OTC transactions on expected market conditions in the early development period of the European Carbon futures market. Past duration and trading intensity are used as information related order flow variables in modelling time between transactions in two new specifications of Autocorrelation Conditional Duration (ACD) models. This allows for specific investigation of non-linear asymmetric effects on expected duration and the impact of OTC transactions. Evidence is presented of two main types of trading episodes of increased and decreased trading intensity. Both have a significant impact on price volatility, which increases further if an OTC transaction intrudes. OTC transactions also play a dual role. They slow down trading activity in the short term (over the next five transactions) but increase it substantially in the long term (over ten transactions). Both the liquidity and information price impact components increase following an OTC trade, but the information impact is greater. Price volatility calms down faster than liquidity effects following an OTC trade, and this is more pronounced in ECX and in Phase II. The combined evidence points towards increased market depth, efficiency and maturity of the trading environment

Visible and Invisible Forces. What Drives the Intensity of Trading in the European Carbon Market?

This study models the trading intensity in European Allowances (EUA) futures contracts, in the European Climate Exchange (ECX) using various specifications and investigates the forecasting ability of observable versus unobservable factors. This set up tests empirically the impact of the evolving market structure through regulatory updates and the contribution of the different market participants to the intensity of trading in the European Carbon market. The findings suggest that observable market characteristics capture better the dynamics of trading intensity than their latent counterparts, which implies that regulatory changes that enhance transparency would also improve market efficiency

The role of trading intensity in duration modelling and price discovery : evidence from the European carbon market

In this study, trading intensity is employed to investigate the role of information and liquidity in duration modelling and price discovery in the two largest exchanges of the European Carbon market, namely European Climate Exchange (ECX) and Nord Pool (NP). First, duration modelling is examined for the first time in this market, and existing ACD models are empirically extended to explore the impact of stylized facts, such as non-linear effects of trading intensity and OTC transactions. Second, the “time dimension” of information is investigated focusing on the informational content of trading intensity. A Smooth-Transition-Mixture of Weibull Distributions ACD (STM-ACD) model that distinguishes between three types of trades is proposed. Time, volume and OTC transactions measure how related related a trade is to information. Third, the price impact of the “time dimension” of information is examined. A new dynamic expectations, structural pricing model is proposed in order to account for the learning process of traders and their expectations. Trading intensity is used to measure the sensitivity of market participants to information and liquidity. The main findings indicate that empirical adjustments significantly improve duration modelling. In consistence with Bauwens et al. (2004), the specification of the conditional mean contributes more to model performance. Trading intensity appears to create a momentum, especially in ECX, whereas OTC transactions seem to slow down the trading process, probably due to information inflow, especially in NP. Furthermore, similar to Easley and O’Hara (1992) higher trading intensity is associated with increased presence of information. Trading intensity is found to be able to distinguish among three different types of trades, according to their informational content. The timing of acquiring information can make it further exploitable. A significant proportion of uninformed traders in the Carbon market is found to observe the market trying to extract price unresolved information. Consequently, informed traders are found to act strategically, according to Kyle (1985), but they are less efficient in covering their actions as market gains complexity, mainly because of higher liquidity levels and improved learning process. In addition, large transactions appear to increase the information price component, while the liquidity component seems to asymmetrically decrease, probably due to economies of scale. Consequently, trading intensity appears to have a dual impact on price, spread and price change volatility, which is determined by current market conditions and dealers’ exposure to risk. Finally, market making in this market seems to be profitable only when expected trading intensity is low

Financial growth and Economic Growth in Europe : Is the Euro Beneficial for All Countries?

International audienceWe revisit the financial-economic growth nexus, accounting for differential effects of large scale legislative frameworks, such as political and financial integration, in Europe. Debt is introduced as an integral component, and potential trifold endogeneity is investigated. Empirical findings show that neither political, nor financial integration, appear to have a direct impact on economic growth. In contrast, only monetary integration has a “dual” “indirect” impact on economic growth. First, the euro allows for improved access to financing, which enhances economic growth. This increases market values, which further accelerate economic growth. This is only evident within Eurozone, highlighting a “euro effect”, whereas political integration seems to be insufficient in engaging the countries in a synergetic endogeneity. Second, the improved access to financing induced by the euro introduces an additional macroeconomic risk of “over-borrowing”. This reverses the abovementioned spiral link by decreasing market values and therefore, lead the economies to spiral contraction. Consequently, the suitability of adopting euro should depend on the ability of each country to balance its dual role, under sustainable financing

Autoregressive Conditional Weighted Duration: Measuring Temporal Dependence of Order Flow in the European Carbon Futures Market.

Trading intensity in the European Carbon market has been found to carry price relevant information, prior to price changes. In this paper we propose a natural measure of trade intensity, the weighted durations, and we model it as a rescaled point process, using the ACD (Engle and Russell, 1998) framework to model liquidity dynamics in the early stages of EU ETS. The new model is called Autoregressive Conditional Weighted Duration (ACWD) and is employed to analyse the trading behaviour of market participants with respects to trading intensity and OTC transactions, as well as intraday uncertainty resolution. The findings confirm the existence of two sources of strong momentums in trading activity and return volatility. OTC trades appear to be strategic, by entering the market when their price impact is minimum. They introduce large in magnitude uncertainty shocks that they need at least five minutes to be absorbed. In parallel, relatively higher trading intensity trades also introduce uncertainty, which is lower in magnitude and takes longer to be resolved into price. Both shocks are absorbed faster in market environments where overall liquidity is higher. This suggests that although absolute liquidity improves overall market maturity, by allowing faster uncertainty resolution, relative liquidity is still linked to higher presence of better informed agents and thus, introduces uncertainty

Does order flow in the European carbon allowances market reveal information?

International audienceThis paper identifies the classes of agents at play in the European Carbon Futures Market and analyzes their trading behaviour during the market's early development period. A number of hypotheses related to microstructure are tested using enhanced ACD models. Evidence is presented that the market is characterized by three different groups of traders: informed, fundamental, and uninformed. OTC trades are distinct to regular trades and are used strategically by the informed. Fundamental traders react faster in Phase II and the informed counteract by increasing their trade size and speed. The results indicate enhanced market transparency and increased market maturity

Why do carbon prices and price volatility change?

International audienceAn asymmetric information microstructural pricing model is proposed in which price responses to information and liquidity vary with every transaction. bid-ask quotes and price components account for learning by incorporating changing expectations of the rate of transacted volume (trading intensity) and the risk level of incoming trades. Analysis of European carbon futures transactions finds expected trading intensity to simultaneously increase the information component and decrease the liquidity component of price changes, but at different rates. This explains some conflicting results in prior literature. Further, the expected persistence in trading intensity explains the majority of the autocorrelations in the level and the conditional variance of price change; helps predict hourly patterns in returns, variance and the bid-ask spread; and differentiates the price impact of buy versus sell and continuing versus reversing trades

Liquidity and resolution of uncertainty in the European carbon futures market

International audienceWe investigate whether liquidity introduces or helps resolve uncertainty in Phase I and the first year of Phase II of the European carbon futures market. We propose a distinction between ‘absolute’ or overall liquidity and that which is ‘relative’ to a benchmark. For this purpose, we suggest volume-weighted duration as a natural measure of trading intensity as a proxy for liquidity, and we model it as a rescaled temporal point process. The new model is called Autoregressive Conditional Weighted Duration (ACWD) and is shown to outperform its discrete modelling counterparts. Liquidity is found to play a dual role, with higher relative liquidity introducing uncertainty and higher absolute liquidity accelerating uncertainty resolution, thus, enhancing market efficiency