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Variance risk-premia in CO2 markets

Julien Chevallier

Economic Modelling, 2013, vol. 31, issue C, 598-605

Abstract: This paper proposes a new methodology to measure the volatility of CO2 assets computed as the difference between model-free implied volatility (from option prices) and model-free realized volatility (from high-frequency intraday data), coined as ‘variance risk-premia’ (Carr and Wu, 2009; Bollerslev et al., 2009; Trolle and Schwartz, 2010), during 2008–2011. We find that variance risk-premia are equal to a daily sample average of 0.79 for European Union Allowances and 0.18 for Certified Emissions Reductions. In the spirit of the CAPM, we show that the beta can only explain a small portion, and that macro risk factors specific to CO2 markets and energy volatilities can improve this result. Hence, there exists a systematic variance risk factor in CO2 markets that asks for a highly risk premium. Further analysis shows that variance risk-premia are time-varying, and can be used as strong predictors for forecasting CO2 returns.

Keywords: Variance risk-premia; CO2 market; Model-free implied volatility; Realized volatility; Forecasting; EUA; CER; EU ETS; CDM; Energy volatilities (search for similar items in EconPapers)
JEL-codes: C5 G1 Q4 (search for similar items in EconPapers)
Date: 2013
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