Combating Air Pollution Through Government Policies

Abstract

Carbon market serves as an emerging commodity market in financial services, where the carbon price returns and volatilities play significant roles in understanding the carbon market dynamics, besides making decisions related to the reduction of carbon emissions. In view of that, this research focuses on examining the cross-commodity volatility spillover effects in the European carbon, fossil fuel and biofuel markets. The sample includes daily closing prices of futures commodities such as carbon, crude oil, coal, natural gas and biodiesel, from March 25, 2008 to July 31, 2019. I employ a bi-variate version of VAR-GARCH-in-mean-BEKK model that allows for flexible distributional assumptions and asymmetry in the variance-covariance matrix. Besides, special attention is given in selecting the appropriate volatility spillover model. The empirical results reveal statistically significant spillover effects, in terms of returns and volatilities, from crude oil and coal markets to carbon market. On the other hand, there are statistically insignificant spillover effects, in terms of returns and volatilities, from natural gas and biodiesel markets to carbon market. These findings could assist the investors to build more effective investment portfolios. Furthermore, power enterprises and other industrial sectors could also regulate their energy consumption structure to attain optimal carbon emission reduction strategies.