Dynamic Price Linkage and Volatility Structure between Carbon Markets

Abstract

This paper investigates the dynamic price linkage and volatility structure between two leading carbon markets of EU allowance (EUA) and secondary certified emission reduction (sCER). We propose a correlation model between EUA and sCER price returns using the marginal abatement cost (MAC) curve and the emission reduction volume. The model reflects twohold market observations: financial players’ EUA-sCER swap transaction in carbon price boom periods and stronger energy price impacts on EUA prices than sCER prices. The model demonstrates that the volatilities are affected by the MAC curve shape and the emission reduction volume while the correlations are indifferent from the MAC curve shape and affected by the emission reduction behavior. The model also suggests that the EUA-sCER price correlations increase when the swap transaction increases or energy prices fall, translated into the opposite EUA price movements of EUA price rise or fall, respectively.