Business Intelligence

Understanding Volatility Dynamics In The EU-ETS Market: Lessons From The Future

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Executive Summary

In this paper the authors study the short term price behavior of December 2008 future prices for EU emission allowances. They model returns and volatility dynamics of this price showing that a standard ARMA-GARCH framework is not adequate and that the gaussianity assumption is rejected due to the occurrence of a number of level and volatility outliers. To improve the fitness of the model, they combine the underlying price process with an additive stochastic jump process. The resulting distribution, a mixture of Gaussians, allows for endogenously determined jumps in the process governing the returns, while the mixing law determines the jump probability.

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