Does Order Flow in the European Carbon Allowances Market Reveal Information?

This paper identifies the classes of agents at play in the European Carbon Futures Market and analyses their trading behaviour during the market's early development period. A number of hypotheses related to microstructure are tested using enhanced three-regime specifications of smooth transition autocorrelated duration (ACD) models. The empirical analysis documents three distinct patterns of trading behaviour supportive of the notion that the market is characterised by three different groups of traders: informed trading characterised by high intensity, uninformed or non-discretionary liquidity trades which arrive randomly, and fundamental or discretionary liquidity trades which have lagged behaviour. There is evidence that OTC trades are distinct to regular trades and are used strategically by the informed. The analysis also suggests that fundamental traders learn or react faster in Phase II and the informed counteract by increasing the size and speed of their trades. This may be indicative of enhanced market transparency and increased market maturity.