Does CEA or EUA matter for major commodity markets? Fresh evidence from the analysis of information spillovers and portfolio diversification

Abstract

PurposeThis study conducts a comparative analysis of the diversification effects of China's national carbon market (CEA) and the EU ETS Phase IV (EUA) within major commodity markets.Design/methodology/approachThe study employs the TVP-VAR extension of the spillover index framework to scrutinize the information spillovers among the energy, agriculture, metal, and carbon markets. Subsequently, the study explores practical applications of these findings, emphasizing how investors can harness insights from information spillovers to refine their investment strategies.FindingsFirst, the CEA provide ample opportunities for portfolio diversification between the energy, agriculture, and metal markets, a desirable feature that the EUA does not possess. Second, a portfolio comprising exclusively energy and carbon assets often exhibits the highest Sharpe ratio. Nevertheless, the inclusion of agricultural and metal commodities in a carbon-oriented portfolio may potentially compromise its performance. Finally, our results underscore the pronounced advantage of minimum spillover portfolios; particularly those that designed minimize net pairwise volatility spillover, in the context of China's national carbon market.Originality/valueThis study addresses the previously unexplored intersection of information spillovers and portfolio diversification in major commodity markets, with an emphasis on the role of CEA.