Asymmetric effects of decomposed oil-price shocks on the EU carbon market dynamics

Abstract

This paper studies the time-frequency and quantile dynamics of the asymmetric relationship between various oil price shocks and the dynamics of the EU carbon emission trading market. According to different sources, oil price shocks are decomposed from the perspectives of supply, demand, and risk of the oil market. Since the price-related information might be only a partial reflection of the market dynamics due to the inefficiency in nature, we extend the convention by gauging the inefficiency degree to explore the true dynamics of the carbon market. The tail dependence is then examined through a quantile coherency approach. Using a daily dataset from 2014 to 2021, our results confirm the asymmetric relationship over the data distribution, and such the asymmetry differs in different time frequencies. The role of oil shocks in impacting the inefficiency degree of the carbon market varies depending on the source of the oil shock. Our results offer comprehensive evidence regarding extreme co-movements between different sources of oil shocks and the carbon market dynamics. The results possess important implications to various stakeholders, especially when they have different time horizon preferences, for risk diversification in investment portfolios and effective emission reductions via the carbon market.