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Improving liquidity in emission trading schemes
Author(s) -
Kim Jihun,
Park Kwangwoo
Publication year - 2021
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.22220
Subject(s) - market liquidity , liquidity crisis , bid price , market maker , business , market impact , ask price , monetary economics , liquidity risk , bid–ask spread , market microstructure , order (exchange) , financial economics , economics , finance , stock market , biology , paleontology , horse
This paper constructs a model of an Emission Trading Scheme (ETS) market using bid‐ask spreads. We show that when such a market is dominated by a small number of traders with substantial market power, they tend to maximize their profits by widening bid‐ask spreads, thereby reducing market liquidity. We argue that adding more market participants, including derivatives traders, can alleviate this illiquidity problem. Policy changes at the European Union's ETS illustrate our theory, as the market significantly increased liquidity by enacting liquidity‐provision policies to attract more participants as it transitioned from Phase 1 to Phase 2.