The Linkages of Carbon Spot-Futures: Evidence from EU-ETS in the Third Phase

Abstract

Based on the prices selected from European Energy Exchange (EEX) from 2013 to 2018, we investigate the inter-correlation of carbon spot and futures markets. Specifically, we adopt the widely used DCC-GARCH model and VAR-BEKK-GARCH model to conduct a comprehensive analysis on the carbon market, i.e., the dynamic correlation and volatility spillover between carbon spot and carbon futures. Moreover, we develop a hedge strategy based on the VAR-BEKK-GARCH model and calculate the hedging effectiveness (HE) value to evaluate the strategy performance. The empirical results show that (i) during our sample period, carbon spot and futures markets are highly correlated, (ii) carbon spot overflows to the futures market and vice versa, and (iii) the HE value is equal to 0.9370, indicating a good performance for the hedging strategy. Then, we provide further discussion on the relationship between carbon spot and futures markets by replacing our dataset with the data of phase II. The results do not change our conclusions on the dynamic correlation and volatility spillover. However, the HE value of phase III is higher than that of phase II, which indicates that the carbon futures market of phase III is not only an available market to hedge risk from the contemporaneous carbon spot market but also has a better hedge effectiveness than phase II.

Correlation and Dynamic Volatility Spillover between Green Investing Market, Coal Market, and CO2 Emissions: Evidence from Shenzhen Carbon Market in China

“…Bollerslev improved the model and proposed the GARCH model, which solved the problem of many lag periods [22]. For the study of volatility spillover effect among financial markets, the most common method used by scholars at home and abroad is the multivariate GARCH model [23][24][25][26]. Li et al found that the multivariate GARCH model can cover multiple factors affecting the market at the same time and provide more information so as to more comprehensively describe the volatility spillover effect between multiple markets [27].…”

Has COVID-19 Changed the Hedge Effectiveness of Bitcoin?

“…The findings of Silvapulle and Moosa (42) discovered the bi-directional non-linear Granger causalities between spot and futures prices in the WTI (West Texas Intermediate) crude oil market. Chen et al (5) focused on the relationships between the carbon spot and futures. Other studies focused on hedging between markets.…”

“…Thereafter, the DCC specification is adopted by numerous investigations to depict the correlation between assets. The DCC model can be summarized by the following Equations (3)(4)(5)(6).…”

“…As a classic financial issue, using futures to hedge risks from the spot market has reached numerous achievements. For example, Chen et al (5) investigated the effectiveness of carbon futures in hedging the risks in the carbon spot market; Zhao et al (6) focused on the hedge strategies between crude oil spot and futures; Chan and Young (7) researched the copper futures and spot; Park and Switzer (8) estimated the optimal hedge ratio for stock and index futures. Benet (9) assessed the hedging effectiveness in the FX market and the like.…”

Time-frequency Connectedness between Coal Market Prices, New Energy Stock Prices and CO2 Emissions Trading Prices in China

“…Different from the literature concerning the traditional fossil fuel energy, D'Adamo [17] notes that new energy, such as photovoltaic resources, could drive the clean global economy of the future and also affect the price of EU CET market. Besides, Chen et al [18] find that CET future market prices could exert an influence on the spot market price too. Through a linear regression model analysis, D'Adamo [19] reveals that the relationship between the circular economy and the price of CO 2 is currently low.…”