Energy Derivatives' Market Dynamics

Abstract

This chapter examines the EU Emissions Trading Scheme options and futures markets dynamics during the period 2005–2011. Observations on returns, volatilities and volumes on derivative instruments are studied. In addition, spot/future correlations, term structures and option implied volatility smiles and surfaces are examined. The aim is to ascertain whether the behavior of the EU ETS derivatives markets can be compared to that of commodity markets, specifically the developed West Texas Intermediate (WTI) crude oil derivatives market. The results indicate that the EU Emissions Trading Scheme derivatives markets have matured markedly since the start of Phase 2 of the Scheme, with rising volumes and declining return volatilities. Spot/future correlations, term structures and option volatility smiles and surfaces exhibit comparable behavior over time, albeit with certain discrepancies, with that found in the developed WTI crude oil derivatives market. These results are valuable both for traders of EU allowances and for those policy makers seeking to improve the design of the EU Emissions Trading Scheme.