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Could Market Making be Profitable in The European Carbon Market?

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We investigate when market making can be profitable in the European Carbon Futures market, by developing an order type selection rule, based solely on transaction level data. We employ a granular approach that uses an observable variable, i.e. trading intensity, to extract the liquidity and information price components and we investigate their impact on spreads, volatility and ultimately on the profitability of different order types. We find that market orders are always less profitable than limit orders. In addition, market makers are expected to derive most of their profits in a low trading intensity environment, mainly due to higher liquidity commissions and a lower probability of dealing with better informed agents. In contrast, an unconditional limit order submission strategy from an off-floor trader should not be preferred, apart from a medium trading intensity environment, where information and liquidity premia adequately compensate them for execution and information risk.

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Keywords: EUA Futures, UHF Trading, Intraday Price Discovery, Market Making

DOI: 10.5547/01956574.40.SI1.egal

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Published in Volume 40, The New Era of Energy Transition of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.


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