Dynamic linkages among carbon, energy and financial markets: a smooth transition approach

Abstract

This article explores how price linkages between carbon allowances and market fundamentals in the EU Emissions Trading Scheme (EU ETS) vary over time. I adopt a multivariate GARCH model that allows the conditional correlation between carbon, energy and financial prices to change smoothly across regimes governed by functions of two transition variables that explain why price linkages vary. I use (i) time as transition variable to allow for structural changes associated with institutional advances in the EU ETS and (ii) implied volatility to account for heterogeneity in the behaviour of correlations in times of distress compared to calm periods. The results point to a new pricing regime with much closer carbonenergy price linkages in the second phase of the EU ETS. Furthermore, I find that correlations depend on market uncertainty conditions, which exposes the link between carbon and financial markets due to common macroeconomic shocks during the current financial crisis.

Speculative and hedging activities in the European carbon market

“…They show that while a cointegrating relationship exists for both phases, the nature of this equilibrium relationship is different across the two sub-periods, with an increasing role of fundamentals in Phase II. Following this line of research, Koch (2014) provides evidence favouring closer carbon and energy price linkages in Phase II as compared to Phase I. Finally, from a market microstructure point of view, Kalaitzoglou and Ibrahim (2013) identify the classes of agents at play in the European carbon futures market and analyse their trading behaviour during the market's early development period.…”

Do oil consumption and economic growth intensify environmental degradation? Evidence from developing economies

“…*Corresponding author. E-mail: sudharshanreddy.paramati@griffithuni.edu.au Applied Economics, 2015http://dx.doi.org/10.1080/00036846.2015 Thus, a plethora of literature (e.g., Menyah and Wolde-Rufael, 2010;Hamit-Haggar, 2012;Koch, 2014) has arisen that analyses the nexus between economic growth, energy consumption and CO 2 emissions. However, most of this literature focuses on aggregated data of energy consumption instead of disaggregated components, such as oil, coal and natural gas.…”

Crude Oil and Agricultural Futures: An Analysis of Correlation Dynamics

“…See Koch () for a comparison between DCC and DSTCC–GARCH in the closely related context of energy and carbon prices.…”

“…4 For a survey of volatility models, seeSerra (2013). 5 SeeKoch (2014) for a comparison between DCC and DSTCC-GARCH in the closely related context of energy and carbon prices.…”