Essay on co2

Resumen

The main objective of this dissertation, entitled #Essays on CO2# is to study how carbon markets function from a financial point of view. In application of the Kyoto Protocol, the European Union launched in 2005 the first Phase of the European Union Emission Trading Scheme (EU ETS), thus beginning the trading of European Union Allowances (EUA) on organized spot and futures markets. A EUA is the right to emit one ton of CO2 in the European Union. The dissertation is organized in four chapters, each one analysing the European carbon market from a different point of view. Specifically, the first chapter explores the main issues concerning allowance trading in the world and compiles the necessary information for a good understanding of this new financial market. This chapter deconstructs all the singularities of carbon trading and specifically the particularities of carbon trading in Europe. The second chapter analyzes the principal determinants of carbon prices during the first year of the EU ETS (2005). The most representative energy variables in Europe, as well as weather variables, when considered in a non-linear way, show statistical influence on carbon returns during 2005. Additionally, the study will allow us not only to gain insights into the relationship between energy-related variables and CO2 prices, but also to shed light on the functional form between weather variables and CO2 returns. The third chapter examines the impact of regulatory decisions on EUA returns and volatility. The results indicate that news releases concerning both the first and the second phases of the EU ETS had an impact on first phase returns but not on volatility. This leads to the interpretation that there was an information leakage before the European Commission#s official announcement. Finally, the last chapter analyses the opportunities for portfolio diversification that the introduction of EUAs offers to the different investors present on the market. We analyse the characteristics of EUAs in both Phase I and Phase II. We examine these two types of assets as sole investments and in various diversified portfolio made up of several combinations of traditional investments and energy variables. We find that even if the weights of EUAs are not too important when incorporated in an optimal and well diversified portfolio, the efficient frontier shows an increase in investor possibilities. Finally, we find that, in most cases, it is indispensable to allow for short sales.