Inefficiencies of Carbon Trading Markets

The European Union Emission Trading System is a prominent market-based mechanism to reduce emissions. While the theory is well understood, we are the first to study the whole cap-and-trade mechanism as a financial market. Analyzing the universe of transactions in 2005-2020 (more than one million records of granular transaction data), we show that this market features significant inefficiencies undermining its goals. First, about 40% of firms never trade in a given year. Second, many firms only trade during surrendering months, when compliance is immediate and prices are predictably high. Third, a number of operators engage in speculative trading, exploiting private information.