The puzzle of Carbon Allowance spread

ArXiv ID: 2405.12982 “View on arXiv”

Authors: Unknown

Abstract

A growing number of contributions in the literature have identified a puzzle in the European carbon allowance (EUA) market. Specifically, a persistent cost-of-carry spread (C-spread) over the risk-free rate has been observed. We are the first to explain the anomalous C-spread with the credit spread of the corporates involved in the emission trading scheme. We obtain statistical evidence that the C-spread is cointegrated with both this credit spread and the risk-free interest rate. This finding has a relevant policy implication: the most effective solution to solve the market anomaly is including the EUA in the list of European Central Bank eligible collateral for refinancing operations. This change in the ECB monetary policy operations would greatly benefit the carbon market and the EU green transition.

Keywords: Cost-of-Carry, Cointegration, Carbon Allowance (EUA), Credit Spreads, Market Microstructure, Carbon Credits

Complexity vs Empirical Score

• Math Complexity: 6.5/10
• Empirical Rigor: 7.0/10
• Quadrant: Holy Grail
• Why: The paper employs advanced econometric techniques like cointegration and error correction models, and uses a custom-built Z-index proxy for credit spreads, indicating substantial mathematical complexity. The analysis is grounded in specific market data (Phase III EU-ETS) with robustness checks, making it data-heavy and backtest-ready.

  flowchart TD
    R["Research Goal: Explain the persistent EUA cost-of-carry spread"]
    D["Data Inputs: EUA Futures, Risk-Free Rate, Corporate Credit Spreads"]
    M["Methodology: Cointegration Analysis & Econometric Modeling"]
    C["Computational Process: Time-series regression and statistical testing"]
    F["Key Finding: C-spread cointegrated with credit spread and interest rate"]
    P["Outcome: Policy Recommendation - Include EUA as ECB Eligible Collateral"]

    R --> D
    D --> M
    M --> C
    C --> F
    F --> P