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This article is the first to examine liquidity and transaction costs in the European carbon futures market. Results indicate a dramatic improvement in liquidity and a subsequent reduction in transaction costs since carbon futures began trading in 2005. On-market liquidity gravitates to December expiry month contracts, coinciding with annual emissions audit requirements. Results also document a widening of the bid–ask spread in response to information asymmetry, and provide evidence of a permanent price effect following medium and large trades.
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