Carbon volatility connectedness and the role of external uncertainties: Evidence from China

• Published in: Journal of commodity markets 2024-03, Vol.33, p.100383, Article 100383
• Main Authors: Chen, Huayi, Shi, Huai-Long, Zhou, Wei-Xing
• Format: Article
• Language: English
• Subjects: Carbon markets; Policy uncertainty; Volatility connectedness
• ISSN: 2405-8513; 2405-8505
• DOI: 10.1016/j.jcomm.2024.100383

This paper investigates the volatility connectedness between China’s carbon pilot markets. Using Diebold and Yilmaz (2014)’s approach based on the time-varying parameter vector autoregression model with a variety of parameter sets, we obtain the average across 40 results to capture the volatility connectedness between the markets. We further use the linear and nonlinear autoregressive distributed lag models to assess the role of external uncertainties in shaping volatility connectedness. Several findings emerge: (1) Guangdong (Chongqing) is the largest net transmitter (receiver) in terms of volatility connectedness; (2) Volatility connectedness shows a declining trend, with its cycle fluctuations caused by compliance-driven trading; (3) Volatility connectedness correlates negatively with external uncertainties. Both economic policy and climate policy indices have impacts on volatility connectedness. We recommend introducing market makers to enhance market liquidity and reduce risk spreading. We also highlight the need for further research to pinpoint idiosyncratic factors that affect different markets. •A time-varying but low level of volatility connectedness is found.•Compliance-driven trading leads to cycle fluctuations in volatility connectedness.•Volatility connectedness is negatively correlated with external uncertainties.•Introducing market makers to improve market liquidity is recommended.•Carbon markets have heterogeneous exposures to various risk sources.