Is the Global Carbon Market Integrated? Return and Volatility Connectedness in ETS Systems
40 Pages Posted: 7 Jun 2022 Last revised: 14 Jul 2022
Date Written: June 1, 2022
Emission trading Scheme (ETS) is gaining momentum with its increasing market size and constantly improving information transmission mechanisms. With carbon assets becoming prominent as an alternative asset in investment portfolios, the ETS market has engaged a broad range of participants, including not only emissions-intensive energy corporations but also individual and institutional investors. As arbitrage opportunities arise, price fluctuations are likely to occur, which typically have a mutual spillover effect. This paper examines how market fluctuations (e.g., volatilities) in these markets interact with each other, among carbon prices across four jurisdictions – European Union, New Zealand, California, and Hubei (China) ETS. We use weekly return and volatility data, constructed by the daily prices from four markets, covering the period April 2014 - December 2021, and select the time-varying parameter (TVP)-VAR methodology to study the connectedness. We find that the dynamics of the carbon market is mainly explained by itself and not due to spillovers from other markets, indicating that the global carbon prices are largely (albeit not completely) dependent on themselves, not the cross-contribution due to individual shocks.
Keywords: Carbon markets integration, Volatility connectedness, TVP-VAR, Market risk
JEL Classification: C32, E44, G15, R11, Q43
Suggested Citation: Suggested Citation