Will the real carbon pricing please stand up?

Abstract

This paper aims at extracting a common factor from major carbon pricing which is interpreted as an effective carbon pricing or a shadow pricing. For this purpose, we use a dynamic factor model for which the unobserved common factors and idiosyncratic noises are potentially nonstationary processes. The two-step Kalman smoother procedure is used to estimate the model. We found (i) that the extracted common factor (i.e., the effective carbon pricing) exhibits very low values which range from 2.05 to 16.1 USD per ton, and more importantly, (ii) this factor does not cointegrate with the market prices. This last result highlights a total lack of integration of carbon markets.