Volatility spillover and dynamic correlation between the carbon market and energy markets
Abstract
This paper studies the volatility spillover and dynamic correlation between EU emission allowance (EUA) prices and energy prices by considering three energy commodities, including oil, gas, and coal. The asymmetric BEKK model is employed for multi-phase analysis of EU ETS, yet only a little empirical evidence backing up the existence of volatility spillover between EU ETS and energy markets, i.e., the establishments of the EU ETS may not effectively limitation and influence energy markets. The time-varying conditional correlation between EUA and each of energy prices is analyzed. The dynamic correlation shows there is a relatively stable, positive correlation between the EUA and Brent oil, natural gas. However, modeling the dynamics correlation also suggests that the correlation between the EUA and the natural gas, coal became weaker and more volatile since second and third phases, especially after the Global Financial Crisis in 2008, which may indicate that the demand reduction in emission allowances caused by the economic slowdown far exceeds the reduction in the annual restraint of EU ETS.
Keyword : volatility spillover, EU ETS, EUA, energy price, asymmetric BEKK model, dynamic correlation
How to Cite
Chen, Y., Qu, F., Li, W., & Chen, M. (2019). Volatility spillover and dynamic correlation between the carbon market and energy markets. Journal of Business Economics and Management, 20(5), 979-999. https://doi.org/10.3846/jbem.2019.10762
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
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Chevallier, J. (2011). A model of carbon price interactions with macroeconomic and energy dynamics. Energy Economics, 33(6), 1295-1312. https://doi.org/10.1016/j.eneco.2011.07.012
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Diebold, F. X., & Yilmaz, K. (2009). Measuring financial asset return and volatility spillovers, with application to global equity markets. Economic Journal, 119(534), 158-171. https://doi.org/10.1111/j.1468-0297.2008.02208.x
Diebold, F. X., & Yilmaz, K. (2012). Better to give than to receive: Predictive directional measurement of volatility spillovers. International Journal of Forecasting, 28(1), 57-66. https://doi.org/10.1016/j.ijforecast.2011.02.006
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Efimova, O., & Serletis, A. (2014). Energy markets volatility modelling using garch. Energy Economics, 43, 264-273. https://doi.org/10.1016/j.eneco.2014.02.018
Engle, R. F., & Kroner, K. F. (1995). Multivariate simultaneous generalized arch. Econometric Theory, 11(1), 122-150. https://doi.org/10.1017/S0266466600009063
Ellerman, A. D. (2008). The EU’s emissions trading scheme: a prototype global system? Social Science Electronic Publishing.
Ellerman, A. D., Convery, F. J., & De Perthuis, C. (2010). Pricing carbon: the European Union emissions trading scheme. Cambridge University Press.
Eugenia Sanin, M., Violante, F., & Mansanet-Bataller, M. (2015). Understanding volatility dynamics in the EU-ETS market. Energy Policy, 82(1), 321-331. https://doi.org/10.1016/j.enpol.2015.02.024
Fezzi, C., & Bunn, D. W. (2009). Structural interactions of European carbon trading and energy markets. The Journal of Energy Markets, 2(4), 53-69. https://doi.org/10.21314/JEM.2009.034
Fan, Y., Jia, J. J., Wang, X., & Xu, J. H. (2017). What policy adjustments in the EU ETS truly affected the carbon prices? Energy Policy, 103(1), 145-164. https://doi.org/10.1016/j.enpol.2017.01.008
Glosten, L. R., Jagannathan, R., & Runkle, D. E. (1993). On the relation between the expected value and the volatility of the nominal excess return on stocks. The Journal of Finance, 48(5), 1779-1801. https://doi.org/10.1111/j.1540–6261.1993.tb05128.x
Hamao, Y., Masulis, R. W., & Ng, V. (1990). Correlations in price changes and volatility across international stock markets. Review of Financial Studies, 3(2), 281-307. https://doi.org/10.1093/rfs/3.2.281
Hu, J., Crijns-Graus, W., Long, L., & Gilbert, A. (2015). Ex-ante evaluation of EU ETS during 2013–2030: EU-internal abatement. Energy Policy, 77(1), 152-163. https://doi.org/10.1016/j.enpol.2014.11.023
Hong, Y. (2001). A test for volatility spillover with application to exchange rates. Journal of Econometrics, 103(1), 183-224. https://doi.org/10.1016/S0304-4076(01)00043-4
Ibrahim, B. M., & Kalaitzoglou, I. A. (2016). Why do carbon prices and price volatility change? Journal of Banking and Finance, 63, 76-94. https://doi.org/10.1016/j.jbankfin.2015.11.004
Ji, Q., Zhang, D., & Geng, J. B. (2018). Information linkage, dynamic spillovers in prices and volatility between the carbon and energy markets. Journal of Cleaner Production, 198, 972-978. https://doi.org/10.1016/j.jclepro.2018.07.126
Jiménez-Rodríguez, R. (2019). What happens to the relationship between EU allowances prices and stock market indices in Europe? Energy Economics, 81(1), 13-24. https://doi.org/10.1016/j.eneco.2019.03.002
Kanamura, T. (2016). Role of carbon swap trading and energy prices in price correlations and volatilities between carbon markets. Energy Economics, 54(1), 204-212. https://doi.org/10.1016/j.eneco.2015.10.016
Keppler, J. H., & Mansanet-Bataller, M. (2010). Causalities between CO2, electricity, and other energy variables during phase I and phase II of the EU ETS. Energy Policy, 38(7), 3329-3341. https://doi.org/10.1016/j.enpol.2010.02.004
Lin, B., & Jia, Z. (2017). The impact of emission trading scheme (ETS) and the choice of coverage industry in ETS: a case study in China. Applied Energy, 205(1), 1512-1527. https://doi.org/10.1016/j.apenergy.2017.08.098
Lutz, B. J., Pigorsch, U., & Rotfuß, W. (2013). Nonlinearity in cap-and-trade systems: The EUA price and its fundamentals. Energy Economics, 40(1), 222-232. https://doi.org/10.1016/j.eneco.2013.05.022
Mansanet-Bataller, M., Pardo, A., & Valor, E. (2007). CO2 prices, energy and weather. Energy Journal, 28(3), 73-92. https://doi.org/10.5547/ISSN0195-6574-EJ-Vol28-No3-5
Mansanet-Bataller, M., & Soriano, P. (2009). Volatility transmission in the CO2 and energy markets. In 2009 6th International Conference on the European Energy Market. IEEE.
Nava, C. R., Meleo, L., Cassetta, E., & Morelli, G. (2018). The impact of the EU-ETS on the aviation sector: competitive effects of abatement efforts by airlines. Transportation Research Part A: Policy and Practice, 113, 20-34. https://doi.org/10.1016/j.tra.2018.03.032
Parsons, J. E., Ellerman, A. D., & Feilhauer, S. (2009). Designing a U.S. Market for CO2. Journal of Applied Corporate Finance, 21(1), 79-86. https://doi.org/10.1111/j.1745-6622.2009.00218.x
Reboredo, J. C. (2014). Volatility spillovers between the oil market and the European Union carbon emission market. Economic Modelling, 36(1), 229-234. https://doi.org/10.1016/j.econmod.2013.09.039
Soliman, A. M., & Nasir, M. A. (2019). Association between the energy and emission prices: An analysis of EU emission trading system. Resources Policy, 61(1), 369-374. https://doi.org/10.1016/j.resourpol.2018.12.005
Wang, Y., & Guo, Z. (2018). The dynamic spillover between carbon and energy markets: New evidence. Energy, 149, 24-33. https://doi.org/10.1016/j.energy.2018.01.145
Xu, L., Deng, S. J., & Thomas, V. M. (2016). Carbon emission permit price volatility reduction through financial options. Energy Economics, 53(1), 248-260. https://doi.org/10.1016/j.eneco.2014.06.001
Zhang, Y. J., & Wei, Y. M. (2010). An overview of current research on EU ETS: evidence from its operating mechanism and economic effect. Applied Energy, 87(6), 1804-1814.
Zhang, Y. J., & Sun, Y. F. (2016). The dynamic volatility spillover between European carbon trading market and fossil energy market. Journal of Cleaner Production, 112, 2654-2663. https://doi.org/10.1016/j.jclepro.2015.09.118
Alberola, E., Chevallier, J., & Chèze, B. (2008b). The EU emissions trading scheme: The effects of industrial production and CO2 emissions on carbon prices. Economie Internationale, 116(4), 93-126. https://doi.org/10.2139/ssrn.1133139
Aatola, P., Ollikainen, M., & Toppinen, A. (2013). Price determination in the EU ETS market: Theory and econometric analysis with market fundamentals. Energy Economics, 36, 380-395. https://doi.org/10.1016/j.eneco.2012.09.009
Akar, C. (2017). Average spillover behavior of Turkish exchange market volatility. In Çilingirtürk A. M., Albrychiewicz Słocinsk, A., & Bülent Bali B. (Ed.), Economics, Management & Econometrics (pp. 123-135). IJOPEC Publication.
Benz, E., & Trück, S. (2009). Modeling the price dynamics of CO2 emission allowances. Energy Economics, 31(1), 4-15. https://doi.org/10.1016/j.eneco.2008.07.003
Baele, L. (2005). Volatility spillover effects in European equity markets. The Journal of Financial and Quantitative Analysis, 40(2), 373-401. https://doi.org/10.1083/jcb.200608066
Bubák, V., Kocenda, E., & Zikes, F. (2011). Volatility transmission in emerging European foreign exchange markets. Journal of Banking & Finance, 35, 2829-2841. https://doi.org/10.1016/j.jbankfin.2011.03.012
Campiglio, E. (2016). Beyond carbon pricing: The role of banking and monetary policy in financing the transition to a low-carbon economy. Ecological Economics, 121, 220-230. https://doi.org/10.1016/j.ecolecon.2015.03.020
Chevallier, J. (2011). A model of carbon price interactions with macroeconomic and energy dynamics. Energy Economics, 33(6), 1295-1312. https://doi.org/10.1016/j.eneco.2011.07.012
Chen, Y., Li, W., & Qu, F. (2019). Dynamic asymmetric spillovers and volatility interdependence on China’s stock market. Physica A: Statistical Mechanics and its Applications, 523, 825-838. https://doi.org/10.1016/j.physa.2019.02.021
Conrad, C., Rittler, D., & Rotfuß, W. (2012). Modeling and explaining the dynamics of European Union Allowance prices at high-frequency. Energy Economics, 34(1), 316-326. https://doi.org/10.1016/j.eneco.2011.02.011
Cui, Q., Li, Y., Wei, Y. M., Cui, Q., Li, Y., & Wei, Y. M. (2017). Exploring the impacts of EU ETS on the pollution abatement costs of european airlines: an application of network environmental production function. Transport Policy, 60, 131-142. https://doi.org/10.1016/j.tranpol.2017.09.013
Dhamija, A. K., Yadav, S. S., & Jain, P. K. (2016). Forecasting volatility of carbon under EU ETS: a multi-phase study. Environmental Economics & Policy Studies, 19(2), 1-37. https://doi.org/10.1007/s10018-016-0155-4
Diebold, F. X., & Yilmaz, K. (2009). Measuring financial asset return and volatility spillovers, with application to global equity markets. Economic Journal, 119(534), 158-171. https://doi.org/10.1111/j.1468-0297.2008.02208.x
Diebold, F. X., & Yilmaz, K. (2012). Better to give than to receive: Predictive directional measurement of volatility spillovers. International Journal of Forecasting, 28(1), 57-66. https://doi.org/10.1016/j.ijforecast.2011.02.006
Du, X., Yu, C. L., & Hayes, D. J. (2011). Speculation and volatility spillover in the crude oil and agricultural commodity markets: A Bayesian analysis. Energy Economics, 33(3), 497-503. https://doi.org/10.1016/j.eneco.2010.12.015
Dutta, A., Bouri, E., & Noor, M. H. (2018). Return and volatility linkages between CO2 emission and clean energy stock prices. Energy, 164(1), 803-810. https://doi.org/10.1016/j.energy.2018.09.055
Efimova, O., & Serletis, A. (2014). Energy markets volatility modelling using garch. Energy Economics, 43, 264-273. https://doi.org/10.1016/j.eneco.2014.02.018
Engle, R. F., & Kroner, K. F. (1995). Multivariate simultaneous generalized arch. Econometric Theory, 11(1), 122-150. https://doi.org/10.1017/S0266466600009063
Ellerman, A. D. (2008). The EU’s emissions trading scheme: a prototype global system? Social Science Electronic Publishing.
Ellerman, A. D., Convery, F. J., & De Perthuis, C. (2010). Pricing carbon: the European Union emissions trading scheme. Cambridge University Press.
Eugenia Sanin, M., Violante, F., & Mansanet-Bataller, M. (2015). Understanding volatility dynamics in the EU-ETS market. Energy Policy, 82(1), 321-331. https://doi.org/10.1016/j.enpol.2015.02.024
Fezzi, C., & Bunn, D. W. (2009). Structural interactions of European carbon trading and energy markets. The Journal of Energy Markets, 2(4), 53-69. https://doi.org/10.21314/JEM.2009.034
Fan, Y., Jia, J. J., Wang, X., & Xu, J. H. (2017). What policy adjustments in the EU ETS truly affected the carbon prices? Energy Policy, 103(1), 145-164. https://doi.org/10.1016/j.enpol.2017.01.008
Glosten, L. R., Jagannathan, R., & Runkle, D. E. (1993). On the relation between the expected value and the volatility of the nominal excess return on stocks. The Journal of Finance, 48(5), 1779-1801. https://doi.org/10.1111/j.1540–6261.1993.tb05128.x
Hamao, Y., Masulis, R. W., & Ng, V. (1990). Correlations in price changes and volatility across international stock markets. Review of Financial Studies, 3(2), 281-307. https://doi.org/10.1093/rfs/3.2.281
Hu, J., Crijns-Graus, W., Long, L., & Gilbert, A. (2015). Ex-ante evaluation of EU ETS during 2013–2030: EU-internal abatement. Energy Policy, 77(1), 152-163. https://doi.org/10.1016/j.enpol.2014.11.023
Hong, Y. (2001). A test for volatility spillover with application to exchange rates. Journal of Econometrics, 103(1), 183-224. https://doi.org/10.1016/S0304-4076(01)00043-4
Ibrahim, B. M., & Kalaitzoglou, I. A. (2016). Why do carbon prices and price volatility change? Journal of Banking and Finance, 63, 76-94. https://doi.org/10.1016/j.jbankfin.2015.11.004
Ji, Q., Zhang, D., & Geng, J. B. (2018). Information linkage, dynamic spillovers in prices and volatility between the carbon and energy markets. Journal of Cleaner Production, 198, 972-978. https://doi.org/10.1016/j.jclepro.2018.07.126
Jiménez-Rodríguez, R. (2019). What happens to the relationship between EU allowances prices and stock market indices in Europe? Energy Economics, 81(1), 13-24. https://doi.org/10.1016/j.eneco.2019.03.002
Kanamura, T. (2016). Role of carbon swap trading and energy prices in price correlations and volatilities between carbon markets. Energy Economics, 54(1), 204-212. https://doi.org/10.1016/j.eneco.2015.10.016
Keppler, J. H., & Mansanet-Bataller, M. (2010). Causalities between CO2, electricity, and other energy variables during phase I and phase II of the EU ETS. Energy Policy, 38(7), 3329-3341. https://doi.org/10.1016/j.enpol.2010.02.004
Lin, B., & Jia, Z. (2017). The impact of emission trading scheme (ETS) and the choice of coverage industry in ETS: a case study in China. Applied Energy, 205(1), 1512-1527. https://doi.org/10.1016/j.apenergy.2017.08.098
Lutz, B. J., Pigorsch, U., & Rotfuß, W. (2013). Nonlinearity in cap-and-trade systems: The EUA price and its fundamentals. Energy Economics, 40(1), 222-232. https://doi.org/10.1016/j.eneco.2013.05.022
Mansanet-Bataller, M., Pardo, A., & Valor, E. (2007). CO2 prices, energy and weather. Energy Journal, 28(3), 73-92. https://doi.org/10.5547/ISSN0195-6574-EJ-Vol28-No3-5
Mansanet-Bataller, M., & Soriano, P. (2009). Volatility transmission in the CO2 and energy markets. In 2009 6th International Conference on the European Energy Market. IEEE.
Nava, C. R., Meleo, L., Cassetta, E., & Morelli, G. (2018). The impact of the EU-ETS on the aviation sector: competitive effects of abatement efforts by airlines. Transportation Research Part A: Policy and Practice, 113, 20-34. https://doi.org/10.1016/j.tra.2018.03.032
Parsons, J. E., Ellerman, A. D., & Feilhauer, S. (2009). Designing a U.S. Market for CO2. Journal of Applied Corporate Finance, 21(1), 79-86. https://doi.org/10.1111/j.1745-6622.2009.00218.x
Reboredo, J. C. (2014). Volatility spillovers between the oil market and the European Union carbon emission market. Economic Modelling, 36(1), 229-234. https://doi.org/10.1016/j.econmod.2013.09.039
Soliman, A. M., & Nasir, M. A. (2019). Association between the energy and emission prices: An analysis of EU emission trading system. Resources Policy, 61(1), 369-374. https://doi.org/10.1016/j.resourpol.2018.12.005
Wang, Y., & Guo, Z. (2018). The dynamic spillover between carbon and energy markets: New evidence. Energy, 149, 24-33. https://doi.org/10.1016/j.energy.2018.01.145
Xu, L., Deng, S. J., & Thomas, V. M. (2016). Carbon emission permit price volatility reduction through financial options. Energy Economics, 53(1), 248-260. https://doi.org/10.1016/j.eneco.2014.06.001
Zhang, Y. J., & Wei, Y. M. (2010). An overview of current research on EU ETS: evidence from its operating mechanism and economic effect. Applied Energy, 87(6), 1804-1814.
Zhang, Y. J., & Sun, Y. F. (2016). The dynamic volatility spillover between European carbon trading market and fossil energy market. Journal of Cleaner Production, 112, 2654-2663. https://doi.org/10.1016/j.jclepro.2015.09.118