Mean and Volatility Spillovers in Emission Allowance and Fuel Returns

Market based emission reduction programs, also known as cap and trade systems, were long promoted by economists as the least-cost method to reduce aggregate pollution levels. The most influential of these programs is the Acid Rain Program launched by Title IV of the 1990 Clean Air Act Amendments to reduce the atmospheric level of sulfur dioxide (SO2) in the United States by capping the level of emissions by fossil-fuel fired electric utilities. In the United States, the main sources of fuel for these utilities are coal, natural gas, and oil. Cap and trade programs introduce an additional market-based cost for complying firms: the cost of an allowance. Given that utilities may substitute away from emission allowances by increasing the volume of natural gas they burn, reducing SO2 emissions per unit of output, or toward allowances by increasing the volume of coal or oil they burn, increasing pollution levels. Thus, one would expect that a cost-minimizing electric utility would seek the lowest cost combination of SO2 allowances, coal, natural gas, and oil for a given level of output. Given this behavior, this paper aims to determine the financial relationship between these four assets, using spot price data for natural gas, oil, and SO2 allowances and futures price data for coal. This paper uses univariate and multivariate GARCH modeling procedures and finds, among other results, evidence that changes in the price SO2 allowances effect changes in the price of coal and natural gas.

Name thesis:degree_name

Master of Arts (MA)

Grantor dc:publisher

University of Montana

Year

2011

Author dc:creator

• Nicholson, Patrick

• volatility transmission
• cap and trade
• GARCH

Repository record dc:identifier

https://scholarworks.umt.edu/etd/655

OAI identifier oai:identifier

oai:scholarworks.umt.edu:etd-1674