Risk Spillovers between China’s Carbon and Energy Markets

Abstract

In recent years, with the intensification of global warming and the greenhouse effect, the global consensus has focused on efficient, clean, low-carbon, and green development as a means of achieving new economic growth. China, as a major carbon emitter, has been at the forefront of efforts to reduce carbon emissions. The establishment of the carbon emissions trading market, commonly known as the “carbon market”, provides an economic solution for reducing carbon emissions in both the carbon and energy markets. As China’s carbon market continues to grow rapidly, fluctuations in the energy or carbon markets caused by information shocks can easily spread between the two markets, leading to increased interconnectedness. Moreover, the spillover effect of the volatility between China’s carbon market and energy market is not constant, and the intensity and direction of this effect vary depending on different market volatility levels and periods. Therefore, it is crucial to conduct a comprehensive study on the characteristics of the volatility spillover effect between China’s carbon market and energy market and to fully understand the mechanism of energy regulation on carbon prices. This research will have significant practical implications for promoting the establishment of a well-functioning internal price transmission mechanism between China’s carbon market and energy market. This study took the risk spillover between the carbon market and energy market as the research object and systematically combed through its pricing mechanism and spillover impact. Through constructing the DY overflow index model based on a VAR model and generalized variance decomposition method, this study explored the linkage between China’s carbon and energy markets, i.e., the linkage of price fluctuations between China’s energy and carbon markets, as well as the time-varying nature of inter-market spillovers, and provides suggestions on the risk control of price fluctuations between the carbon and energy markets.

Keywords

• carbon market
• energy market
• risk spillover
• DY spillover index