Exploring the asymmetric influence of economic policy uncertainty on the nonlinear relationship between exchange rate and carbon prices in China

Abstract

Our objective is to investigate the impact of economic policy uncertainty (EPU) on the risk spillover effect between exchange rates and carbon prices. First, we employ the time-varying parametric vector autoregression (TVP-VAR) method to assess the dynamic nonlinear risk spillover effect between four exchange rates and China's carbon price for the period from September 2, 2013, to April 29, 2022. Our findings reveal a significant time-varying spillover effect between exchange rates and carbon prices. Among them, carbon prices and the EUR/CNY exchange rate predominantly act as risk contributors, and a pronounced correlation is observed among various exchange rates. Furthermore, the magnitude of risk spillover and interdependence intensifies significantly in response to major events. Second, we employ quantile-to-quantile regression (QQR) to examine the impact of EPU on risk spillover. Our results indicate that the influence of EPU on risk spillover exhibits is characterized by marked asymmetry and heterogeneity. At high levels of EPU, EPU has a substantial positive impact on risk spillover. However, when the risk spillover is already elevated, the effect of EPU tends to diminish. Based on these findings, we propose several policy recommendations, including prudent treatment of exchange rate adjustments, fostering stability in carbon prices, and the enactment of robust economic policies.