The Linkages of Carbon Spot-Futures: Evidence from EU-ETS in the Third Phase

Hao Chen,You Wu,Yinpeng Zhang,Zhixin Liu

doi:10.3390/su12062517

Hao Chen, You Wu + Show 2 more

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https://doi.org/10.3390/su12062517

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Abstract

Based on the prices selected from European Energy Exchange (EEX) from 2013 to 2018, we investigate the inter-correlation of carbon spot and futures markets. Specifically, we adopt the widely used DCC-GARCH model and VAR-BEKK-GARCH model to conduct a comprehensive analysis on the carbon market, i.e., the dynamic correlation and volatility spillover between carbon spot and carbon futures. Moreover, we develop a hedge strategy based on the VAR-BEKK-GARCH model and calculate the hedging effectiveness (HE) value to evaluate the strategy performance. The empirical results show that (i) during our sample period, carbon spot and futures markets are highly correlated, (ii) carbon spot overflows to the futures market and vice versa, and (iii) the HE value is equal to 0.9370, indicating a good performance for the hedging strategy. Then, we provide further discussion on the relationship between carbon spot and futures markets by replacing our dataset with the data of phase II. The results do not change our conclusions on the dynamic correlation and volatility spillover. However, the HE value of phase III is higher than that of phase II, which indicates that the carbon futures market of phase III is not only an available market to hedge risk from the contemporaneous carbon spot market but also has a better hedge effectiveness than phase II.

Highlights

One of the most thought-provoking issues globally is global warming, given its potential damage to agricultural production, industrial manufacture and human sustainable development [1,2]
Similar to our research for phase III of the European Union Emission Trading Scheme (EU-ETS), we still conduct a T-test to further certify whether the two markets are correlated, and the results shows the correlation between carbon spot and futures to be dynamic
We collect our data set of carbon spot and futures market in phase III of the European Union (EU)-ETS to analyze the dynamic correlation and volatility spillover of the two markets

Summary

Introduction

One of the most thought-provoking issues globally is global warming, given its potential damage to agricultural production, industrial manufacture and human sustainable development [1,2]. The Kyoto Protocol established three mechanisms for climate change mitigation. Among all of the three mechanisms, emission trading is a unique way for carbon reduction, as it reduces carbon emissions through a market-based mechanism, which makes carbon reduction a market activity [3]. Based on the Kyoto Protocol, the European Union established the famous European Union Emission Trading Scheme (EU-ETS) in 2005. The EU-ETS has been operating successfully for three phases. The fourth phase of the scheme will launch in 2021, lasting for 10 years until late 2030 [4]. Due to the vast trading volume and drastic price changes, the EU-ETS has become the largest carbon trading market and is viewed as a common financial market for analyzing financial characteristics and portfolio management [5]

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Discussion

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