Correlation Between Investor Sentiment and Carbon Price Considering Economic Policy Uncertainty

Abstract

Based on the linkage between the carbon asset and its related assets, an European Union investor sentiment (EUIS) index reflecting investor behavior in the EU carbon market is constructed using the principal component analysis (PCA) method, and the dynamic correlation relationship between the EUIS index and the EU allowance (EUA) futures prices is analyzed. Furthermore, the European economic policy uncertainty (EEPU) index is introduced and the GARCH-MIDAS model is applied to discuss the impact of macroeconomic uncertainty on the EUIS index. The empirical results indicate that the EUIS index constructed from indicators of the carbon asset and its related assets can reflect the sentiments of carbon market investors. There is a dynamic correlation between the EUIS index and EUA futures, with reverse correlation dominating. The significant fluctuations in their correlation are related to the occurrence of major events. The volatility of the EUIS index is negatively affected by realized volatility and positively affected by EEPU. The model confidence set (MCS) test shows that the prediction accuracy of the GARCH-MIDAS model considering low-frequency macroeconomic variables is better than that of GARCH models.