Pricing efficiency and arbitrage in the EU ETS carbon futures market

In this review of carbon futures pricing we review some of the results published recently by Milunovich and Joyeux (2007) who investigate the extent of market efficiency, and other related issues, in the European Union carbon futures market. Preliminary results indicate that none of the three carbon futures contracts examined are priced according to the cost-of-carry model, although two of the three contracts formed stable long-run links with the carbon spot price and interest rates. Our findings raise the possibility of profitable arbitrage opportunities in this US$24 billion market as well as the existence of effective risk mitigation instruments.