Short-term contrarian in the carbon emission market

Abstract

We consider the short-term contrarian effects in daily data from carbon emission markets. Technical analysis is conducted with three contrarian trading rules on four carbon emission markets of China. Various individual and joint test statistics are developed for testing the contrarian profits from individual trading path as well as a group of trading paths. Empirical evidence shows that the contrarian profits are statistically and economically significant across the technical rules. Particularly, the contrarian moving average group trading generates average returns of 3.8 to 13.8 % per month across the different carbon markets during the period of 2013–2023 and the corresponding Sharpe ratios range from 0.9 to 2.01, while the Sharpe ratios from the buy-and-hold strategy are all below 0.12. Further tests support that the contrarian profits are not eliminated by transaction costs, and not dominated by extreme returns. We also emphasize on the explanations of the contrarian profit. Among the considered variables, the market volatility is the most significant explanatory variable for contrarian profits across four markets, whereas the market illiquidity and non-trading breaks are also significant in certain markets. The finding supports the explanation of the behavioural bias of overreaction for the short-term contrarian effect. Other explanations, including short-selling constraint, clearing stress, price limits, government interventions, etc. are also discussed in the paper.