Abstract
Utilities with hard coal and lignite power plants, manufacturers, and aviation companies in the EU that emit greenhouse gases must invest in emission allowances to run their operations. The buy side of the capital market (e.g. hedge funds, insurers, and pension plans) can invest in these allowances to realise an investment asset which is uncorrelated to traditional market-risk investments. Given the high volatility of the price of emission allowances, all investors in emission allowances face a challenging risk-return situation that requires a thorough risk analysis. We show that this analysis can be undertaken using extreme value theory. For the analysed extreme emission allowance price returns, we identified saliently good fits between the empirical and theoretical Pareto distributions. We further show that emission allowances present an interesting investment case.
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Notes
As we are here interested in an investment case, we corrected the monthly ECarbix time series for two extreme outlier values that had occurred on 31.01.2013 and 31.03.2014. In both cases, a substantial surplus of emission allowances and a corresponding awareness by the market participants could serve as at least one important reason for these significant negative monthly returns.
Sample kurtosis value of the ECarbix without the correction of the outliers is 6.5170; see figure 1.
For five investment portfolios of alternatively 1, 2, 5, 8, and 10% of the total volume invested in the ECarbix and the remaining fraction in the DAX index, the null hypothesis of the Andersen–Darling test, that the portfolio log returns are logistic distributed, could in all cases not be rejected for a level of significance higher than 25%.
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Treptow, T.M. CO2 investment risk analysis. J Asset Manag 25, 19–30 (2024). https://doi.org/10.1057/s41260-023-00342-z
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DOI: https://doi.org/10.1057/s41260-023-00342-z
Keywords
- Investing in greenhouse gas emission allowances
- Investment risk analysis
- Extreme value theory
- Asset allocation