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Modeling and forecasting the volatility of carbon dioxide emission allowance prices: A review and comparison of modern volatility models

Mawuli Segnon, Thomas Lux and Rangan Gupta ()

Renewable and Sustainable Energy Reviews, 2017, vol. 69, issue C, 692-704

Abstract: The launch of the markets for carbon dioxide emission allowances was guided by the aim to use the supposedly efficient price formation mechanism of an organized exchange to optimally allocate a certain quantity of emissions among potential polluters. While this introduction of a centralized trading arrangement should have helped to achieve required emission reductions with a minimum of economic losses, from the viewpoint of market participants it has raised concerns about appropriate risk management provisions to cope with the fluctuations of time-varying allowance prices. The present review provides an overview over state-of-the-art models for price volatility expanding the scope from relatively simple GARCH-type models to models with long-term dependence and regime switches including the relatively recent class of so-called multifractal models. We provide a comparative application of these models to carbon dioxide emission allowance prices from the European Union Emission Trading Scheme and evaluate their performance with up-to-date model comparison tests based on out-of-sample forecasts of future volatility and value-at-risk.

Keywords: Carbon dioxide emission allowance prices; GARCH; Markov-switching GARCH; FIGARCH; Multifractal processes; SPA test; Encompassing test; Backtesting (search for similar items in EconPapers)
JEL-codes: Q47 (search for similar items in EconPapers)
Date: 2017
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