Impact of economic policy uncertainty on the volatility of China's emission trading scheme pilots

Abstract

This paper aims to investigate the impact of the economic policy uncertainty (EPU) on the volatility of China's emission trading scheme (ETS) pilots. Based on the GARCH-MIDAS model, we proxy EPU using two domestic EPU indices and two global EPU indices and explore their impacts on the volatility of three representative ETSs, Hubei, Guangdong, and Beijing ETS pilots in China from 2014 to 2020. Our findings are threefold. Firstly, the effects on the volatility differ significantly across the ETS pilots and EPU indices. When the weighted value of the growth rate of EPU increases by 0.01 unit, the long-term volatility of Hubei and Beijing ETSs rises by 9.371%–28.777% and 1.629%–5.444%, respectively. For Guangdong, the volatility increases by 11.926%–22.713% when the domestic EPU rises and decreases by 38.302%–59.063% when the global EPU rises. Secondly, economic policy events affect the volatility of ETS pilots by adjusting industries' production, and such influence is alleviated by stabilization mechanisms of the carbon market. Finally, the GARCH-MIDAS model incorporating EPU indices has superior out-of-sample prediction ability in the Hubei and Beijing ETS. This study provides important policy implications for government to stabilize the volatility of ETS and a reliable method for investors to construct portfolios.