Investigating Long-term Multi-phase EUA Price

Dynamics

Mohammed Ballouti

University of Amsterdam
12334766

July 7, 2022

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Carbon Market
Started out as first commitment period of the Kyoto Protocol.
EU Emission Trading System (EU ETS) was introduced in 2005.
First large greenhouse gas emissions trading scheme in the world.
Cap and trade system of European Emission Allowances (EUA).

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Research questions

1 How does the multi-phase EU ETS affect both the energy (renewable
and non-renewable) and stock markets from a time-varying
perspective?
2 How does the long-term volatility spillover and dynamic correlation
between the EUA price and price drivers change with and without the
inclusion of structural breaks?

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Contribution to the literature and Data

Long-term investigation including structural breaks.

Inclusion of renewable growth and macroeconomic growth indicators.

Table: Overview of variables used in thesis

Symbol Name D
EUA European Emission Allowance Futures price
CLEAN S&P Global Clean Energy Index
OIL Brent oil Futures price
GAS New York Mercantile Exchange (NYMEX) GAS price
COAL ICE Rotterdam Coal
STOXX Index of futures and options traded on the EURO STOXX 50

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Literature

Interdependence between energy markets and EU ETS

(1) Significant interdependence between Carbon-based variables and EUA
(Aatola et al. (2013)).

(2) Clear relationship becomes stronger in the second phase

commodities.Creti et al. (2012).

(2) Robust evidence of macroeconomic activitiy and renewable energy

affecting EUA prices (Koch et al. (2014)).

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Literature

Volatility research of EU ETS

(1) Chevallier (2012) finds significant cross volatility spillovers between
EUA price and Oil/Gas.

(2) Zhang and Sun found significant unidirectional volatility spillover

between coal, oil and gas. DCC gives coal prices are the only carbon
commodity price to significantly and negatively affect the EUA return.

(3) Yu et al. (2015) find that dynamic spillover changes over time and
decreases in size from phase II to phase III.

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Methodology: ICSS

Iterative Cumulative Sum of Squares developed by Inclan and Tao (1994)

is a structural break detection algorithm. For a volatility series
a = {at1 , at2 . . . , aT }, we calculate the following test statistic:
r Pk !
2
T − t1 + 1 i=1 at i k
M(k) = max | PT − |.
t1 <k<T 2 2
i=1 at i
T

If M(k) > 1.358, then there is a structural break at point k.

old t1 old T

Mohammed Ballouti Research Thesis Process July 7, 2022 7 / 14

Methodology: ICSS

Iterative Cumulative Sum of Squares developed by Inclan and Tao (1994)

is a structural break detection algorithm. For a volatility series
a = {at1 , at2 . . . , aT }, we calculate the following test statistic:
r Pk !
2
T − t1 + 1 i=1 at i k
M(k) = max | PT − |.
t1 <k<T 2 2
i=1 at i
T

If M(k) > 1.358, then there is a structural break at point k.

k∗

old t1 old T

Mohammed Ballouti Research Thesis Process July 7, 2022 7 / 14

Methodology: ICSS

Iterative Cumulative Sum of Squares developed by Inclan and Tao (1994)

is a structural break detection algorithm. For a volatility series
a = {at1 , at2 . . . , aT }, we calculate the following test statistic:
r Pk !
2
T − t1 + 1 i=1 at i k
M(k) = max | PT − |.
t1 <k<T 2 2
i=1 at i
T

If M(k) > 1.358, then there is a structural break at point k.

k∗

old t1 old T

Mohammed Ballouti Research Thesis Process July 7, 2022 7 / 14

Methodology: ICSS

Iterative Cumulative Sum of Squares developed by Inclan and Tao (1994)

is a structural break detection algorithm. For a volatility series
a = {at1 , at2 . . . , aT }, we calculate the following test statistic:
r Pk !
2
T − t1 + 1 i=1 at i k
M(k) = max | PT − |.
t1 <k<T 2 2
i=1 at i
T

If M(k) > 1.358, then there is a structural break at point k.

k∗

old t1 old T

no breaks

Mohammed Ballouti Research Thesis Process July 7, 2022 7 / 14

Methodology: ICSS

Iterative Cumulative Sum of Squares developed by Inclan and Tao (1994)

is a structural break detection algorithm. For a volatility series
a = {at1 , at2 . . . , aT }, we calculate the following test statistic:
r Pk !
2
T − t1 + 1 i=1 at i k
M(k) = max | PT − |.
t1 <k<T 2 2
i=1 at i
T

If M(k) > 1.358, then there is a structural break at point k.

new t1 k∗

old t1 old T

no breaks

Mohammed Ballouti Research Thesis Process July 7, 2022 7 / 14

Methodology: ICSS

Iterative Cumulative Sum of Squares developed by Inclan and Tao (1994)

is a structural break detection algorithm. For a volatility series
a = {at1 , at2 . . . , aT }, we calculate the following test statistic:
r Pk !
2
T − t1 + 1 i=1 at i k
M(k) = max | PT − |.
t1 <k<T 2 2
i=1 at i
T

If M(k) > 1.358, then there is a structural break at point k.

new t1 k∗

old t1 old T

no breaks

Mohammed Ballouti Research Thesis Process July 7, 2022 7 / 14

Methodology: ICSS

Iterative Cumulative Sum of Squares developed by Inclan and Tao (1994)

is a structural break detection algorithm. For a volatility series
a = {at1 , at2 . . . , aT }, we calculate the following test statistic:
r Pk !
2
T − t1 + 1 i=1 at i k
M(k) = max | PT − |.
t1 <k<T 2 2
i=1 at i
T

If M(k) > 1.358, then there is a structural break at point k.

new t1 k∗ new T

old t1 old T

no breaks no breaks

Mohammed Ballouti Research Thesis Process July 7, 2022 7 / 14

Methodology: ICSS

Iterative Cumulative Sum of Squares developed by Inclan and Tao (1994)

is a structural break detection algorithm. For a volatility series
a = {at1 , at2 . . . , aT }, we calculate the following test statistic:
r Pk !
2
T − t1 + 1 i=1 at i k
M(k) = max | PT − |.
t1 <k<T 2 2
i=1 at i
T

If M(k) > 1.358, then there is a structural break at point k.

new t1 k∗ new T

old t1 old T

no breaks reiterate algorithm here no breaks

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Methodology: BEKK

BEKK model is given by:

xt = E (xt |Ft−1 ) + at
1/2
at = Σt zt
n m
0 0 0 0
X X
Σt = CC + Ai at−1 at−1 Ai + Bj Σt−1 Bj for t = 1, . . . , T .
i=1 j=1

Estimation is done by optimizing the MLE on the residuals of a VAR

model. The Berndt, Hall, Hall and Hausman (BHHH) algorithm is used to
optimize.

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Methodology: aDCC
Model is given by:

Σt = Dt ρt Dt
qij,t
ρij,t =
qii,t qjj,t
0 0
Qt = Q̄(1 − θ1 − θ2 ) + θ1 εt−1 εt−1 θ2 Qt−1 + θ3 (vt−1 vt−1 − N̄).

Estimation process happens in two steps:

Construct a univariate EGARCH model for each return series and
introduce ICSS dummies:
n
X
ht2 =ω+ α|ε2t−1 | + γ1 ε2t−1 + βg (Zt ) + dt,i Dt,i .
i=1

Estimate Q̄ and N̄ using maximum likelihood with

Broyden-Fletcher-Goldfarb-Shanno (BFGS) algorithm.
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BEKK results
Below the GARCH matrix along with volatility spillovers are given with
and without structural breaks.

Table: with structural breaks

EUA CLEAN OIL GAS COAL STOXX

EUA 0.90483*** -0.0023 0.00378 -0.0110 0.00202 -0.0025

CLEAN 0.03283*** 0.94131*** -0.0485*** -0.0352*** -0.0442*** -0.0185***
OIL -0.0002 0.02008*** 0.92511*** -0.0375*** -0.0066 -0.0164***
B
GAS 0.00873 0.02806*** 0.03318*** 0.93798*** 0.01688*** -0.0104***
COAL 0.03228*** 0.02032*** 0.01504** 0.04132*** 0.95639*** -0.0079*
STOXX -0.0067 0.05658*** 0.01934** 0.05155*** 0.03067*** 0.96371***

Table: without structural breaks

EUA CLEAN OIL GAS COAL STOXX

EUA 0.91006*** 0.00090 0.00778 -0.0140* -0.0011 -0.0032

CLEAN 0.02582*** 0.94071*** -0.0481*** -0.0330*** -0.0441*** -0.0254***
OIL 0.00373 0.02077*** 0.92120*** -0.0426*** -0.0095 -0.0135***
B
GAS 0.01455** 0.02991*** 0.03126*** 0.93627*** 0.01257*** -0.0085**
COAL 0.03289*** 0.02466*** 0.02145*** 0.04193*** 0.95622*** -0.0088*
STOXX -0.0052 0.05995*** 0.02029** 0.04648*** 0.03697*** 0.96052***

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aDCC Title

Table: DCC model with and without structural breaks

DCC with breaks DCC without breaks

Variable Parameter Coefficient Std. Error Coefficient Std. Error
EUA µ 0.0007** 0.0003 0.0008** 0.0003
AR(1) 0.3284*** 0.0174 0.3146*** 0.0497
MA(1) -0.380*** 0.0183 -0.369*** 0.0492
ω -0.400*** 0.0310 -0.171*** 0.0150
α1 -0.047*** 0.0132 -0.035*** 0.0115
β1 0.9483*** 0.0038 0.9762*** 0.0020
γ1 0.2103*** 0.0217 0.2155*** 0.0234

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Volatility and Dynamic Correlation graphs

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Brief summary

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Any questions OR Clarification

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