Risk spillovers across the energy and carbon markets and hedging strategies for carbon risk
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Date
Authors
Balcilar, Mehmet
Demirer, Rıza
Hammoudeh, Shawkat
Nguyen, Duc Khuong
Journal Title
Journal ISSN
Volume Title
Publisher
Elsevier
Abstract
This study examines the risk spillovers between energy futures prices and Europe-based carbon
futures contracts. We use a Markov regime-switching dynamic correlation, generalized
autoregressive conditional heteroscedasticity (MS-DCC-GARCH) model in order to capture the
time 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 on
both the regime dependent and regime independent optimal hedge ratios. We finally complement
our analysis by examining the in- and out-of sample hedging performances for alternative
strategies. Our results mainly show significant volatility and time-varying risk transmission from
energy markets to carbon market. We also find that spot and futures segments of the emission
markets exhibit time-varying correlations and volatile hedging effectiveness. The subsample
estimates show significant changes in the hedge effectiveness over the different phases of the
European carbon market. These results have important investment and policy implications.
Description
Keywords
Multivariate regime-switching, Time-varying correlations, Hedging, CO2 allowance prices, Markov regime-switching dynamic correlation, generalized autoregressive conditional heteroscedasticity (MS-DCC-GARCH) model
Sustainable Development Goals
Citation
Balcilar, M, Demirer, R, Hammoudeh, S & Nguyen, DK 2016, 'Risk spillovers across the energy and carbon markets and hedging strategies for carbon risk', Energy Economics, vol. 54, pp. 159-172