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Carbon Emissions Pricing: Linkages Between EU ETS Spot and Future Prices and Completeness of EU ETS Market

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  • Saikat Mondal
  • Rudra P. Pradhan
  • Vinodh Madhavan
  • Debaleena Chatterjee
  • Ann Mary Varghese

Abstract

The study examines the relationship and linkages between spot and future prices of European Union Emission Trading Systems (EU-ETS) during 2019–2021. Dynamic conditional correlation specification of multivariate generalized autoregressive conditional heteroskedasticity (MGARCH) model was employed to examine the time-varying correlation between spot and future prices. Also, vector autoregression mean model and MGARCH-Baba-Engle-Kroner-Kraft volatility model was jointly estimated to model the spillover between EU ETS spot and future prices in the first and second moments. Lastly, we utilize the variance-covariance matrix of joint mean-variance model estimation to derive the optimal conditional hedge ratio as well as the hedge effectiveness of EU ETS future contracts. Our findings reveal a high conditional correlation and significant spillover between carbon spot and future markets in EU. Further, our study uncovers a high degree of hedge effectiveness for EU ETS future contracts. This is possibly the first study that examines the linkages between EU ETS spot and future prices pertaining to the recent transition stage of phase III and the initial stage of ongoing phase IV of the ETS market. Our findings pinpoint to ETS markets becoming more complete and in turn offering optimal hedging avenues. JEL Codes: G15, C58, Q38

Suggested Citation

  • Saikat Mondal & Rudra P. Pradhan & Vinodh Madhavan & Debaleena Chatterjee & Ann Mary Varghese, 2024. "Carbon Emissions Pricing: Linkages Between EU ETS Spot and Future Prices and Completeness of EU ETS Market," Journal of Emerging Market Finance, Institute for Financial Management and Research, vol. 23(4), pages 450-470, December.
    • Handle: RePEc:sae:emffin:v:23:y:2024:i:4:p:450-470
    DOI: 10.1177/09726527241248003
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    References listed on IDEAS

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    More about this item

    Keywords

    Carbon pricing mechanisms; European Union; dynamic correlation; conditional volatility; volatility spillover; hedge effectiveness;
    All these keywords.

    JEL classification:

    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • Q38 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Government Policy (includes OPEC Policy)

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