Scandinavian Working Papers in Economics

Working Papers,
Copenhagen Business School, Department of Economics

No 7-2022: Is the Global Carbon Market Integrated? Return and Volatility Connectedness in ETS Systems

Chenyan Lyu () and Bert Scholtens ()
Additional contact information
Chenyan Lyu: Department of Economics, Copenhagen Business School, Postal: Copenhagen Business School, Department of Economics, Porcelaenshaven 16 A. 1. floor, DK-2000 Frederiksberg, Denmark
Bert Scholtens: Department of Finance, University of Groningen

Abstract: Emission trading 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 model has engaged a broad range of market 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. The data used in this paper consists of weekly return and volatility, constructed by the daily prices from four markets, covering the period 30th April 2014, through 1st December 2021. We focus theoretically on the time-varying parameter (TVP)-VAR methodology, and empirically the connectedness approach. Our empirical results show average return (volatility) spillover is 6.03% (8.25%), which means that the dynamics of each of the carbon market are mainly explained by themselves and not due to spillovers from other markets, indicating that the global carbon prices are largely (albeit not completely) dependent.

Keywords: Carbon markets integration; Volatility connectedness; TVP-VAR; Market risk

JEL-codes: C32; E44; Q43; R11

Language: English

38 pages, First version: May 23, 2022. Revised: June 8, 2022.

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