PRICE DISCOVERY AND MARKET EFFICIENCY IN THE EUROPEAN CARBON MARKET

Abstract

The European Union Emission Trading Scheme (EU-ETS) has emerged as the primary environmental regulatory initiative of the EU and a successful market-based approach aimed at combating climate change. EU-ETS is a highly policy-driven market, with regulatory decisions and government interventions shaping its structure and price dynamics. This thesis analyzes the performance of EU-ETS from a market microstructural perspective, aiming to understand price discovery and market efficiency in its recent phases (Phase III and Phase IV). The thesis first synthesizes the fragmented literature on the global carbon markets using bibliometric and content analysis. Over the last two decades, there is a considerable growth in literature on carbon pricing, which we further classify into major research themes, i.e., risk and volatility dynamics, price discovery and market efficiency, the impact of news and regulatory announcements, determinants of carbon prices, integration of global carbon markets with other financial markets, and the existence of herding behavior. The existing literature focuses majorly on carbon price drivers and the connectedness of the EU-ETS market with other financial markets. There is a notable scarcity of research on price discovery and market efficiency in the recent phases of EU-ETS. To fulfill this gap, this thesis conducts three empirical studies that investigate price discovery (the impounding of new information into the security prices) and market efficiency (the informativeness of prices) using data from two major EU-ETS trading platforms, i.e., the “European Energy Exchange (EEX)” and “European Climate Exchange (ECX)”.