Working Paper: CEPR ID: DP18118
Authors: Estelle Cantillon; Aurelie Slechten
Abstract: We document the impact of market fragmentation during the first phase of the EU emissions trading scheme on the terms that traders were able to get. We observe the universe of over-the-counter (OTC) and exchange transactions and the transaction prices associated with four of the 11 exchanges that were active during that period. We define a measure of price advantage based on the difference between the transaction price and the median market-wide price that day. We decompose price advantage into its exchange, counterparty and trader drivers and show that where traders traded and how connected they and their counterparties were with the rest of the market covary with the terms they were able to obtain. Such features are expected to characterize OTC transactions but not, typically, anonymous exchange transactions. The high level of market fragmentation during the first phase, which was a policy choice, hampered information aggregation about the overall balance between supply and demand in the market, and put small and non-energy compliance traders at a large disadvantage.
Keywords: trading networks; price formation; market frictions
JEL Codes: D47; D85; G12; Q58
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Market fragmentation (F12) | Price aggregation (C43) |
| Market fragmentation (F12) | Price advantage for traders (F14) |
| Trader connectivity (L14) | Price advantage (F14) |
| Exchange characteristics (F31) | Price advantage (F14) |
| Local supply-demand conditions (R22) | Price advantage (F14) |
| Market fragmentation (F12) | Disadvantage for small compliance traders (F14) |
| Connectivity of exchanges (D85) | Price discovery (D47) |
| Market structure and trader characteristics (D49) | Trading outcomes (L14) |