Trading patterns in the European carbon market: The role of trading intensity and OTC transactions

• We examine the effect of trading intensity and OTC trades on market conditions in the European Carbon futures market.
• Two types of trading episodes are found.
• High Trading Intensity trades have an increased liquidity and volatility impact, especially when OTC trades are involved.
• OTC trades play a dual role. They non-monotonically increase liquidity and the information related price component.
• Liquidity and volatility shocks are lower in magnitude and are absorbed faster in ECX, indicating greater market maturity.

This paper examines the effect of trading intensity and OTC transactions on expected market conditions in the early development period of the European Carbon futures market. Past duration and trading intensity are used as information related order flow variables in modelling time between transactions in two new specifications of Autocorrelation Conditional Duration (ACD) models. This allows for specific investigation of non-linear asymmetric effects on expected duration and the impact of OTC transactions. Evidence is presented of two main types of trading episodes of increased and decreased trading intensity. Both have a significant impact on price volatility, which increases further if an OTC transaction intrudes. OTC transactions also play a dual role. They slow down trading activity in the short term (over the next five transactions) but increase it substantially in the long term (over ten transactions). Both the liquidity and information price impact components increase following an OTC trade, but the information impact is greater. Price volatility calms down faster than liquidity effects following an OTC trade, and this is more pronounced in ECX and in Phase II. The combined evidence points towards increased market depth, efficiency and maturity of the trading environment.