Friedrich, Marina Mauer, Eva-Maria Pahle, Michael Tietjen, Oliver
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Now in its third compliance period, we can look back at more than 12 years of existence of the emissions trading system (ETS) in the European Union. The focus of this paper is to review the empirical literature on price formation in the EU ETS. As a reoccurring concept, we draw on a simple theoretical model of price formation that we subsequently extend to accommodate three different strands of literature. First, we gather evidence based on empirical papers which look at the role of fundamental price drivers. Second, we review the event study literature, where political and regulatory uncertainty is the main topic. Third, we devote a major part to finance literature in this market. In every section, we pay special attention to the challenges that arise when empirically modeling allowance prices in this complex market. We emphasize that there is a need for more evidence and possibly alternative approaches due to the complex interplay of compliance and finance trading motives. As a result, the findings of this review provide important lessons about price formation in the EU ETS, which can also inform the design of such programs in other countries.