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What do we know about spillover between the climate change futures market and the carbon futures market?

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Abstract

Climate action-based assumptions and tradable characteristics underpinned the development of climate change futures contracts, which are related to carbon and climate markets. Therefore, this paper examines return and volatility spillover between climate change futures and carbon allowance futures using dynamic conditional correlation (DCC) and asymmetric dynamic conditional correlation (ADCC) models with daily and weekly frequency data. Considering the emergence of US market-based carbon futures and climate futures, this study explores bivariate optimal hedging strategies and optimal portfolio strategies. Using daily data, this study discovers unidirectional and positive return and volatility spillover from the carbon futures market to the climate change futures market, implying opportunities for diversification and hedging. The weekly analysis shows bidirectional and negative return spillover between the carbon futures market and the climate change futures market, implying opportunities for risk hedging. In addition, it also reveals unidirectional and positive volatility spillovers from the carbon futures market to the climate change futures market. The carbon market dominates the climate change futures market. The study also reveals that optimal portfolio strategies will be preferred over optimal hedging strategies. Therefore, this study offers practical implications for investors and portfolio managers.

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Notes

  1. The concept of a spillover effect can be understood as a phenomenon observed within financial markets, whereby fluctuations occurring in one market, known as the source market, are transmitted to another market, referred to as the recipient market.

Abbreviations

CCF:

ICE MSCI US Climate Change Futures

CCAF:

California Carbon Allowance Futures market

ERS:

Elliott-Rothenberg-Stock Unit Root Test

PP:

Philips-Perro Unit Root Test

ADF:

Augmented Dickey-Fuller Unit Root Test

DCC:

Dynamic conditional correlation

ADCC:

Asymmetric dynamic conditional correlation

CCC:

Constant conditional correlation

GARCH:

Generalized AutoRegressive Conditional Heteroskedasticity

CO2:

Carbon dioxide

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Authors and Affiliations

  1. BRAC Business School, BRAC University, 66 Mohakhali, Dhaka, 1212, Bangladesh

    Mohammad Enamul Hoque

  2. Faculty of Economics and Administrative Sciences, Erciyes University, 38039, Kayseri, Turkey

    Faik Bilgili

  3. Department of Finance and Economics, E. Craig Wall Sr. College of Business Administration, Coastal Carolina University, 119 Chanticleer Drive West, Conway, SC, 29526, USA

    Sourav Batabyal

  4. Grant Center for Real Estate and Economics, E. Craig Wall Sr. College of Business Administration, Coastal Carolina University, 119 Chanticleer Drive West, Conway, SC, 29526, USA

    Sourav Batabyal

Authors
  1. Mohammad Enamul Hoque
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Contributions

Conceptualization, methodology, formal analysis and investigation, writing—original draft preparation, writing—review and editing, and resources: MEH, SB, and FB; supervision: FB.

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Correspondence to Faik Bilgili.

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Hoque, M.E., Bilgili, F. & Batabyal, S. What do we know about spillover between the climate change futures market and the carbon futures market?. Climatic Change 176, 166 (2023). https://doi.org/10.1007/s10584-023-03640-y

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