Risk spillovers across the energy and carbon markets and hedging strategies for carbon risk

摘要

This study examines the risk spillovers between energy futures prices and Europe-based carbonfutures contracts. We use a Markov regime-switching dynamic correlation, generalizedautoregressive conditional heteroscedasticity (MS-DCC-GARCH) model in order to capture thetime variations and structural breaks in the spillovers. We further evaluate the optimal weights,hedging effectiveness, and dynamic hedging strategies for the MS-DCC-GARCH model based onboth the regime dependent and regime independent optimal hedge ratios. We finally complementour analysis by examining the in- and out-of sample hedging performances for alternativestrategies. Our results mainly show significant volatility and time-varying risk transmission fromenergy markets to carbon market. We also find that spot and futures segments of the emissionmarkets exhibit time-varying correlations and volatile hedging effectiveness. The subsampleestimates show significant changes in the hedge effectiveness over the different phases of theEuropean carbon market. These results have important investment and policy implications.