Capital market response to emission allowance prices : a multivariate GARCH approach

This study assesses the impact of European emission allowances (EUA) prices on stock prices of all companies in the StoxxEurope Total Market Index belonging to sectors regulated by the European Union Emission Trading Scheme (EU ETS). The effect of allowance prices on stock prices is found to be firm specific. For most companies, EUA prices are found to be positively correlated to stock prices of regulated companies. This is the case for all sectors. Different mulitvariate GARCH models, generalised least squares panel models and aggregated models are compared. We show that models which ignore covariances of the regression errors between firms are inefficient and that imposing a common carbon effect for all firms creates aggregation bias.