Quantifying Liquidity in Emissions Allowance Markets: Issues and Perspectives

Transcription

1 Quanifying Liquidiy in Emissions Allowance Makes: Issues and Pespecives Daf Dooa Baye *, Maiela Boell and Ulf Moslene Cene fo Euopean Economic Reseach (ZEW), P.O. Box , Mannheim, Gemany. Absac. On Januay 1 s 2005 he EU Emissions Tading Scheme was esablished, giving bih o a new make wih some similaiies o ohe financial makes. Howeve, many sudies quesion he liquidiy of he Euopean cabon pemi make. The objecive of his pape is o povide an oveview of liquidiy measues as hey ae used fo ohe financial makes and o examine whehe i is possible o apply hem o he Euopean cabon pemi make. On he basis of seleced measues we analyse he impac of allowance make design on make liquidiy. JEL classificaion: G18, Q54 Keywods: emissions ading, liquidiy, financial insumens Acknowledgemens: We acknowledge financial suppo fom ZEW * Coesponding auho: baye@zew.de

2 Non-Technical Summay On Januay 1 s 2005 he EU Emissions Tading Scheme (EU-ETS) was officially launched. Since hen moe han 10,000 lage indusial plans in he EU have been able o buy and sell pemis o elease cabon dioxide ino he amosphee. As a consequence a new ineesing make wih some similaiies o ohe financial makes has emeged. One of he main oles of financial makes is o povide he abiliy o ansfe he owneship of a secuiy beween vaious economic agens. In his conex liquidiy can be defined as he degee o which lage size ansacions can be caied ou in a imely fashion wih a minimal impac on pices. In a liquid make, economic agens would be able o buy o sell an unlimied amoun of a secuiy quickly, a low cos, and a a pice close o he obseved pice. On he ohe side, an illiquid make is one whee economic agens would be able o ade secuiies a pices diffeen fom he las aded pice and o cay ou lage size ansacions only wih a long ime lag. Hence, he lack of liquidiy esuls in a discepancy beween he pice and he fai value of a given secuiy. Due o he impac on secuiy pices, i is impoan o measue liquidiy. The poblem how o quanify liquidiy of financial makes is boadly discussed in he lieaue. Since he ems lage size ansacion, imely fashion and minimal impac on pices end o be subjecive, liquidiy is no measued as an absolue sandad, bu on a scale which incopoaes key elemens of volume, ime and ansacion coss. The objecive of he pape is o examine whehe i is possible o apply liquidiy measues used fo ohe financial makes o emissions allowance makes. We fis give an oveview of exising liquidiy measues and idenify poblems conneced wih applying hem o emissions allowance makes. Subsequenly we consuc new liquidiy measues which allow avoiding idenified poblems. In he second pa of ou sudy he impac of allowance make design on make liquidiy is consideed. We paiculaly analyse vaious make design elemens, such as banking and boowing, as well as make sucues, like exchanges and ove-he-coune makes. As a esul, he mos desiable emissions allowance make design elemens ae idenified.

3 1 Inoducion A he beginning of 2005, he Euopean Union has launched is flagship insumen on conolling cabon dioxide emissions - he Emissions Tading Scheme (EU ETS). This capand-ade sysem is subsanially lage han ohe pogams which have peviously been inoduced in he Unied Saes. As opposed o he flexible insumen of he Kyoo Poocol, ypically called Inenaional Emissions Tading (IET), he acos of he pemi make in he EU ETS ae individual companies and no he counies. Wihin he scope of he EU ETS moe han 10,000 lage indusial plans, such as powe poduces o efineies, ae now able o buy and sell pemis o elease cabon dioxide ino he amosphee. In economic heoy he pemi pice can be inepeed as a signal fo he scaciy of emission pemis, defined by he oveall emissions budge decided on he poliical level. This pice signal consiues impoan infomaion fo he fims subjec o a ading scheme. Fisly, hey base hei poducion decision on he pemi pice, weighing he possibiliy of educing emissions hough bee echnologies o lowe poducion wih he subsequen selling of he access pemis agains he alenaive of buying addiional pemis wih an incease of poducion. Secondly, he fims have o come up wih expecaions on he fuue pemi pice befoe making invesmen decisions. Fo example, fo a company consideing whehe o build a coal-fied powe plan, a gas ubine o a combined biomass hea and powe plan, he pice of cabon dioxide would be one of he mos impoan facos deemining is decision. Theefoe fims acing in he pemi make need a cedible pice fo hei decisions and migh be ineesed in hedging he cabon pice isk. Fo boh, assessing cedibiliy of he pemi pice signal as well as fo he developmen of financial insumens based on cabon value, i is impoan o know whehe he Euopean cabon make can be consideed liquid. Howeve, a ecen poll conduced by he ZEW in Mannheim, Gemany, evealed ha a majoiy among moe han 200 enegy pofessionals does no conside he pemi make as liquid. Quaniaive evidence on he degee of liquidiy in he EU ETS is scace. In his pape we povide an oveview of exising liquidiy measues as hey ae used in ohe financial makes. Theeafe we idenify poblems conneced wih applying hese measues o emission allowance makes and examine how liquidiy of he EU ETS could be quanified in a meaningful manne. Based on his analysis we idenify design elemens of pemi makes which have a lage impac on make liquidiy.

4 2 Liquidiy - definiion and measues One of he main oles of financial makes is o povide he abiliy o ansfe he owneship of a secuiy beween vaious economic agens. In his conex liquidiy can be defined as he degee o which lage size ansacions can be caied ou in a imely fashion wih a minimal impac on pices. In a liquid make, economic agens would be able o buy o sell an unlimied amoun of a secuiy quickly, a low cos, and a a pice close o he obseved pice. On he ohe side, an illiquid make is one whee economic agens would only be able o ade secuiies a pices diffeen fom he las aded pice and o cay ou lage size ansacions only wih a long ime lag. Since he definiion incopoaes he key elemens of volume, ime and ansacion coss, hee dimensions of make liquidiy can be disinguished deph, beadh and esiliency. Deph is he abiliy of he make o absob lage ansacions wihou having a lage effec on pices and is measued on he volume of ansacions necessay o move pices. Beadh, also efeed o as ighness, is efleced by bid-ask speads in he make. Resiliency is he speed wih which pices eun o equilibium following a lage ade [Kyle (1985)]. The poblem how o quanify he above-named dimensions of liquidiy is boadly discussed in he lieaue. Below we give an oveview of exising measues and discuss hei popeies. 2.1 Deph measues Deph of a make is defined as he abiliy of he make o absob lage ansacions wihou causing an appeciable change in pice [Kyle (1985)]. In ode o assess he deph of a given make, he volume of ansacions necessay o move pices has o be esimaed. This can be done in many diffeen ways. Fo example, Amihud (2002) and Poe (2003) esimae deph measues based on he aveage pice impac pe uni of ading volume. When make deph is low, pice concessions equied fom make makes ae lage pe uni of volume han when make deph is high. Poe (2003) calculaes his measue as follows: D n D 1 d, γ =, (1) Dn d = 1 vd,

5 whee D n is he numbe of ading days in monh, is a daily pecenage pice change and v is he daily volume of ansacions. The measue is defined as he negaive of he daily aveage so ha lage negaive values signify low liquidiy. The esuling seies is hen inflaed by he aio of he oal value of shaes a he end of he pevious monh o he oal value of shaes a he end of he base monh. One dawback of using dolla volume in he above measue is ha equal size ades may have diffeen pice impac due o diffeences in, fo example, he numbe of shaes ousanding, diffeences in floa, and diffeences in he numbe and ypes of shaeholdes. Theefoe Poe (2003) examines a modified vesion of he pice impac measue: D n D* 1 γ =, (2) d, d = ( 1+ STO ) Dn 1 d, whee STO i, d, sands fo unove on day d in monh, divided by he aveage daily unove in he pevious monh. Tunove fo a given day is hee defined as volume divided by he value of all shaes a he end of he pevious monh. Gossmann and Mille (1988) define he deph aio as he aveage volume of ading o he aveage pice change duing some ineval. Consideing a monhly peiod of ime he aio can be calculaed as follows: D n vd, D d = 1 ϕ =. (3) D n d = 1 d, A high value o he aio indicaes ha many shaes wee aded wih lile pice change and is evidence of high deph. A low value poins a low deph of he make and suggess ha only one lage ansacion can induce a lage pice change. Anohe dynamic measue of make deph developed by Engle and Lange (1997) is consuced fom he excess of buye o selle iniiaed ansacions duing a make even defined by a pice movemen. The auhos inoduce a em of pice duaion which is defined as he ime and all ansacions beween subsanial movemens in he midpoin of he quoes. The measue is defined as: M D υ = k v, (4) m m= 1 m m

6 whee k m is he diecion of ade indicao (buy = 1 and sell = -1), v m is he numbe of shaes aded and M is he numbe of ansacions wihin a paicula pice duaion. If a pice incease occus wih only a small excess of buyes han he make is illiquid, bu if he same pice incease is associaed wih a lage excess of buyes han he deph is gea. This deph indicao is expessed in shaes pe pice change and has a diec inepeaion of how much one sided volume can be ansaced wihou diving he pices moe han a given amoun. 2.2 Beadh measues Beadh efes o he divegence of ansacion pices fom he ue equilibium valuaion of a given asse. Pefec liquidiy wih espec o beadh could be eached only if ades would be able o buy and sell an asse a he same pice. In he ealiy, make makes se he bid and ask quoes slighly below and above he efficien pice, so ha an inveso wishing o ade immediaely can only sell (buy) a he quoed bid (ask) pice ha includes a concession (pemium) fo immediae execuion. Theefoe he spead beween he bid and he ask pices, which is he sum of he concession and pemium, divided by he midpoin of he spead, is a naual measue of liquidiy. Assuming ha he bid and ask quoes saddle he ue value of he sock symmeically, evey buy o sell ode incus ansacion coss equal o one half of he spead. Poe (2003) pesens wo following measues of make beadh: D n B 1 γ = RQS, (5) d, Dn d = 1 whee RQS, is a daily aveage elaive quoed spead, defined as he aveage of evey bes d bid and offe eligible quoe divided by he quoe midpoin, and D n B 1 υ = RES, (6) d, Dn d = 1 whee RES, is a daily aveage elaive effecive spead, defined as he aveage of he d absolue value of he diffeence beween each ansacion pice and he midpoin of he mos ecen quoe. Inceasing speads ae associaed wih deceasing liquidiy, heefoe he leading negaive sign is added so ha smalle values of he indicaos ae associaed wih lowe liquidiy, consisen wih ohe measues.

7 Accoding o Muanaga (1999), he bid/ask spead povides bee infomaion abou he liquidiy han unove and he numbe of ades in ha i shows how much he cos will be in he case of an immediae ansacion. Howeve, he bid-ask spead as a saic indicao only expesses he ansacion cos fo hose who wish o execue a maginal ade in he make, and does no povide infomaion abou how many unis will be absobed (deph of ode book) o abou he exen o which a pice will move afe limi odes a he bes quoed pice have been digesed (pice coninuiy of ode book). Such infomaion can be gaheed fom he dynamic indicaos make impac and make esiliency. Fuhemoe Muanaga povides empiical evidence abou he elaionship beween a high ade fequency and high make liquidiy in a saisic sense wih a small bid-ask spead. Gossmann and Mille (1988) analyze he limiaions of he bid-ask spead as a measue of liquidiy as well. Accoding o hese auhos, he bid-ask spead measues he make make s eun fo poviding immediacy exacly only in he special case, in which he make make simulaneously execues boh sides of he ade, he one a he bid and he ohe a he ask side. In he moe ypical case, he odes do no aive simulaneously bu ae andomly sepaaed in ime. If so, he pice may change beween he ime a which he make make buys and sells so ha he may ean much moe o less ha he spead quoed a he ime of he fis leg of he ansacion. 2.3 Resiliency measues Resiliency is an aspec of liquidiy associaed wih empoay pice flucuaions induced by ode flow. Kyle (1985) defines esiliency as he speed wih which pices eun o equilibium following a lage ade. The esiliency measues ely on he pinciple ha ode flow induces geae eun evesals when make liquidiy is low. The monhly liquidiy measue of Paso and Sambaugh (2001), esimaed using wihinmonh daily euns and volumes of a given asse, epesens he aveage effec ha a given volume on day d has on he eun fo day d+1, when he volume is given he same sign as he eun on day d. Specifically, he liquidiy measue fo monh is he odinay-leas squaes R (OLS) esimae of γ i, in he egession: e ( i, d, ) vi, d, i, d 1 = θ φ γ ε, (7) e R i, d + 1, i,. + i, i, d, + i, sign + +,

8 whee i d,, is he eun on sock i on day d in monh, m, d is he make eun on day d in, monh, e i, d, i, d, m, d, v, = and i, d is he dolla volume fo sock i on day d in monh. The basic idea is ha if signed volume is viewed oughly as ode flow hen lowe liquidiy is efleced in a geae endency fo ode flow in a given diecion on day d o be followed by a pice change in he opposie diecion on day d+1. The geae is he expeced evesal fo a R given dolla volume, he lowe is he sock s liquidiy. Tha is, one would expec γ i, o be negaive in geneal and lage in absolue magniude when liquidiy is lowe. The pecise specificaion of he egession is somewha abiay, as is any liquidiy measue. The eun in excess of he make e i, d, is used boh as he dependen vaiable as well as o sign volume, in ode o bee isolae he individual-sock effec of volume-elaed eun evesals. The auhos also include he lagged sock eun as a second independen vaiable wih he inenion of capuing lagged-eun effecs ha ae no volume-elaed such as evesals due o a minimum ick size. Fo ha pupose he oal eun i d,, is used insead of he eun in excess of he make simply o have his second vaiable be somewha less coelaed wih he vaiable whose coefficien seves as he liquidiy measue. The main R poblem of he egession (7) is ha he aw seies of γ i, s is subjec o he upwad end in dolla values and volumes ove he peiod, so he values of γ R i, end o be smalle in magniude lae in he peiod. To obain moe homogeneiy ove ime, he auhos consuc he scaled seies ( m ) R m1 i, / γ, whee m is he oal dolla value a he end of monh -1 of he socks of he make aded in he make in monh, and monh 1 coesponds o he fis monh of he sample. Anohe possible alenaive is o subsiue unove (dolla volume divided by end of pevious monh make capializaion) fo dolla volume, alhough, as Paso and Sambaugh (2001) poin ou, his is simila o simply value weighing hei measue. One dawback of he wo poposed liquidiy measues conneced wih he use of dolla volume is ha equal size ades may have diffeen impac due o diffeences in, fo example, he numbe of shaes ousanding, diffeences in floa, and diffeences in he numbe and ypes of shaeholdes. A possible way o deal wih his poblem is o subsiue unove scaled by aveage daily unove duing he pevious monh fo dolla volume in egession (7). This measue of ansacion volume will be high when daily volume is high elaive o a

9 ecen ime seies aveage and allows capuing any unusual volume wihou he need o inflae he aveage coefficien by oal make capialisaion. Accoding o Muanaga (1999), esiliency povides infomaion abou poenial ade needs which is no explicily placed in he make as an ode. He suggess o calculae esiliency by measuing he widened bid-ask spead caused by ade execuions and he peiod of ime equied fo he spead o be esoed o he sae exising immediaely befoe he execuion as R aio _ of _ bid / ask _ pice _ change follows: ψ =. (8) esoaion _ ime _ of _ bid / ask _ spead I should be noed ha in an acual make esiliency may no be obsevable a evey ade since new make odes could well be placed befoe he bid-ask spead has been esoed by new limi odes. By aking ino accoun such make odes occuing duing he spead esoaion peiod, he concep of make esiliency can come close o being an obsevable liquid indicao. Fuhemoe Muanaga (1999) povides empiical evidence abou he elaionship beween a high ade fequency and spead declining ae. This suggess ha ade fequency and make esiliency have posiive coelaion. Besides he hee dimensions of liquidiy descibed so fa, hee ae also ohe measues poposed in he lieaue. Fo example, Gossmann and Mille (1988) use he numbe of make makes as a measue of make liquidiy modelled as being deemined by he demand and supply of immediacy. Exogenous liquidiy evens coupled wih he isk of delayed ade ceae a demand fo immediacy. Make makes supply immediacy by hei coninuous pesence and willingness o bea isk duing he ime peiod beween he aival of final buyes and selles. In he long un, he numbe of make makes adjuss o equae he supply and demand fo immediacy. This deemines he equilibium level of liquidiy in he make. The lowe is he auocoelaion in aes of euns, he highe is he equilibium level of liquidiy. Moeove, ading fequency, eflecing he numbe of ades execued wihin a specified ineval wihou egad o ade size, can be used as a poxy fo liquidiy. High ading fequency may indicae a liquid make, bu i can be also associaed wih volailiy and hence lowe liquidiy.

10 3 Quanifying Liquidiy in Emission Pemi Makes In geneal, all he measues pesened in he pevious chape can be applied o evey kind of financial makes. Howeve, if we conside applying hem o emission pemi makes, some echnical poblems aise. Fisly, he definiion of he Euopean cabon pemi make is no clea. Since he EU ETS allowances ae aded a seveal exchanges, like he Inenaional Peoleum Exchange IPE in London, he Euopean Climae Exchange ECX in Amsedam o Nod Pool in Oslo, we can eihe assess and compae liquidiy of he paicula exchanges o analyse he exchanges all ogehe like one make. The poblem in he inegaed appoach would be ha ading is oganized diffeenly a evey exchange. Moeove he majoiy of ansacions sill ake place in he OTC-make, whee ansacions don have o be disclosed. 4 Conclusions and fuhe eseach In his pape we analyze he poblem of quanifying liquidiy in emission pemi makes. Ou analysis is based on seleced liquidiy measues as hey ae used fo ohe financial makes. We pesen he measues divided in hee dimensions deph, beadh and esiliency. Ou analysis povides us wih he following esuls. Fisly, emission allowances makes ae vey simila o ohe financial makes, so i is possible o use pesened measues fo he assessmen of liquidiy in his specific make. Howeve, as he ading ake place a many exchanges and due o he dominan ole of he OTC-make, only liquidiy a paicula exchanges can be assessed and compaed. Moeove, i is possible o compae hese exchanges wih ohe makes, like sock exchanges. One diecion fo fuue eseach is o compae he liquidiy of he exchanges enabling ading wih emissions pemis among each ohe on he base of he eal daa. This sudy akes a sep on his pah by poposing seleced measues fo he analysis. Fuue eseach could also invesigae wha could be undeaken o impove liquidiy in emission pemi makes.

11 Refeences Choida T., Saka A., Subahmanyam A.(2003): An empiical analysis of sock and bond make liquidiy Engle R. F., Lange J. (1997): Measuing, Foecasing and Explaining Time Vaying Liquidiy in he Sock Make, NBER Woking Pape, 6129 Gossman S.J., Mille M.H. (1988): Liquidiy and Make Micosucue, The Jounal of Finance, 43/3: Kyle, A. S. (1985): Coninuous aucions and inside ading, Economeica, 53: Muanaga, J. (1999): Dynamics of make liquidiy of Japanese socks: An analysis of ick-by-ick daa of he Tokyo Sock Exchange, Bank of Japan Muanaga, J., Shimizu T. (1999): Make Micosucue and Make Liquidiy Paso L., Sambaugh R. F. (2001): Liquidiy isk and expeced sock euns, The Cene fo Reseach in Secuiy Pices, Woking Pape No. 531, Augus 2001 Pesaud, A. C. (2001): Liquidiy black holes, Sae See Global Insighs Poe R.B. (2003): Measuing Make Liquidiy, Ocobe 2003: 2-10