How connected is the carbon market to energy and financial markets? A systematic analysis of spillovers and dynamics

Xueping Tan, Kavita Sirichand, Andrew Vivian and Xinyu Wang

Energy Economics, 2020, vol. 90, issue C

Abstract: Carbon allowances are a new class of financial instrument which aim to assist in limiting the extent and impact of global warming and climate change. The feedback mechanism in the “Carbon-Energy-Finance” system makes the information connectedness dynamics more complex since we add equity, bond and non-energy commodity assets into the system. Using modified error variance decomposition and network diagrams, we quantify and systematically analyze how the European carbon market connects with information from a wide range of other markets. Our results indicate: (i) the nature of information spillover changes over time, with system-wide return connectedness being higher and more variable than the volatility interdependence; (ii) both the oil and carbon markets closely connect with equity and non-energy commodity markets rather than bond markets; (iii) we identify three structural breaks in carbon volatility and their implication for carbon-finance linkages; (iv) financial risk-type macroeconomic factors make greater contributions to system-wide connectedness than commodity factors. These findings have economic implications for investors, portfolio managers and policymakers.

Keywords: Carbon market; Financial markets; Structural breaks; Connectedness; Error variance decomposition; Macroeconomic determinants (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (108)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:90:y:2020:i:c:s0140988320302103

DOI: 10.1016/j.eneco.2020.104870

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