Modelling the price spread between EUA and CER carbon prices

This paper identifies factors impacting on the dynamics of the price spread between European Allowances (EUAs) and Certified Emission Reductions (CERs) by detecting changes in the structural relationship between them. While prior studies have assumed a fixed structural relationship, this paper analyses the dynamic evolution of the price spread by employing a time-varying parameter analysis using daily data from March 2008 to September 2011. The analysis reveals that a lack of competitive conditions in markets, access constraints on the use and the availability of CERs, regulatory changes regarding both EUAs and CERs, and uncertainty surrounding CERs can explain a significant portion of the price spread.

► This paper identifies factors impacting on the price spread between EUAs and CERs.
► It allows for a dynamic structural change by using a time-varying parameter model.
► The analysis reveals that uncertainty surrounding CERs can explain the spread.
► In addition to different market frameworks, caps on CERs contribute to the spread.
► Regulatory changes regarding both markets explain the dynamics of the price spread.