Forecasting the Volatility of European Union Allowance Futures with Climate Policy Uncertainty Using the EGARCH-MIDAS Model

Xinyu Wu, Xuebao Yin and Xueting Mei
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Xinyu Wu: School of Finance, Anhui University of Finance and Economics, Bengbu 233030, China
Xuebao Yin: School of Finance, Anhui University of Finance and Economics, Bengbu 233030, China
Xueting Mei: School of Finance, Anhui University of Finance and Economics, Bengbu 233030, China

Sustainability, 2022, vol. 14, issue 7, 1-13

Abstract: We propose the EGARCH-MIDAS-CPU model, which incorporates the leverage effect and climate policy uncertainty (CPU) to model and forecast European Union allowance futures’ (EUAF) volatility. An empirical analysis based on the daily data of the EUAF price index and the monthly data of the CPU index using the EGARCH-MIDAS-CPU model shows that the EUAF’s volatility exhibits a leverage effect, and the CPU has a significantly negative impact on the EUAF’s volatility. Furthermore, out-of-sample analysis based on three loss functions and the Model Confidence Set (MCS) test suggests that EGARCH-MIDAS-CPU model yields more accurate out-of-sample volatility forecasting results than various competing models. There is room for further application of the model, such as this model could be applied to price carbon futures, so as to improve the liquidity of the carbon market and achieve carbon peak and carbon neutrality as soon as possible.

Keywords: European Union allowance futures; climate policy uncertainty; volatility forecasting; EGARCH-MIDAS model; MCS test (search for similar items in EconPapers)
JEL-codes: O13 Q Q0 Q2 Q3 Q5 Q56 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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