The timeline of trading frictions in the European carbon market

- We compare Phases I and II of the EU-ETS from a microstructure angle.
- Phase II shows lower spreads, information-asymmetry risk and market making profits.
- The contribution of noise to the volatility of prices increased during Phase II.

During its trial phase (Phase I), the EU Greenhouse Gas Emission Trading Scheme (EU-ETS) collapsed because of an over-allocation of emission allowances. We evaluate the progress of this market from the trial phase to the next commitment period (Phase II) from a microstructure angle. We show that trading frictions, as measured by the relative spread, information-asymmetry risk, and market-making profits decreased from Phase I to Phase II. Although volatility decreased, its noise-related component gained in importance at the expense of its information-related component, resulting in lower quality of the price changes.