The market (in-)stability reserve for EU carbon emission trading: Why it might fail and how to improve it

Our simulations indicate that the triggers of the proposed MSR appear to be set too low for the hedging need of power producers, effectively leading to a stricter cap in its initial 10-15 years of operation. While the current proposal may be improved by choosing different triggers, a reserve that is based on volume triggers is likely to increase price volatility, contrary to its purpose. Additional problems are the two-year delay in the response time and the abruptness of the response function, combined with the difficulty of estimating future hedging behaviour.