Structural breaks in certificate markets. The impact of regulatory changes on certificate price volatility

Within the European Union (EU), national governments are responsible to introduce their own measures for stimulating the introduction of renewable energy sources in the electric power sector. However, a common support mechanism might benefit member countries mitigating the differences in natural resources potential, providing least-cost production of renewable electricity. The recent incorporation of Norway into the Swedish certificate market created the first international certificate market for renewable energy in the world, representing a possible model for integration of support mechanisms within the whole EU. This paper analyzes the impact of incorporating Norway into the Swedish market on the certificate price volatility. Initially, the return of the certificate spot price is modeled using a Generalized Autoregressive Conditional Heteroskedasticity (GARCH) approach, which assumes constant unconditional variance and time-varying conditional variance dependent on previous periods. Then, the Iterated Cumulative Sums of Squares (ICSS) methodology is applied to the residuals obtained from the model to detect structural breaks in the certificate unconditional variance. GARCH models are then estimated for the subsamples defined by the structural breaks, and changes in the unconditional variance between subsamples are analyzed. By this approach, it is possible to estimate the impact of regulatory changes on the volatility of the certificate price. The paper concludes discussing the events that could have caused the breaks in the certificate price volatility with particular attention to changes in regulatory policy.