Trading Patterns in the European Carbon Market: The Role of Trading Intensity and OTC Transaction.

This paper examines the effect of trading intensity and OTC transactions on expected market conditions in the early development period of the European Carbon futures market. Past duration and trading intensity are used as information related order flow variables in modelling time between transactions in two new specifications of Autocorrelation Conditional Duration (ACD) models. This allows for specific investigation of non-linear asymmetric effects on expected duration and the impact of OTC transactions. All recorded transactions of the most heavily traded December 2008 futures contract occurring during Phase I (2005-2007) and the first year of Phase II (2008) in the two largest exchanges (ECX and Nord Pool) of the European Carbon Market are investigated. Evidence is presented of two main types of trading episodes of increased and decreased trading intensity. Both have a significant impact on price volatility which increases further if an OTC transaction intrudes. OTC transactions also play a dual role. They slow down trading activity in the short term (over the next five transactions) but increase it substantially in the long term (over ten transactions). Both their transitory and permanent price impact components increase, but the permanent impact is greater. Price volatility calms down faster than liquidity effects following an OTC trade, and this is more pronounced in ECX and in Phase II. The combined evidence also points to increased market depth, efficiency and maturity of the trading environment