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Coping with the liquidity crisis: a new dynamic quota readjustment scheme for carbon markets

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Abstract

Because of insufficient liquidity, prices in the carbon market are more vulnerable to unexpected events, for which the impact duration lasts longer than that of the general market. The root reason for this phenomenon lies in the irrationality of quota distribution. The existing quota adjustment schemes and policies, e.g., the market stability reserve (MSR) and some recent adjustment measures, have poor timeliness and effectiveness, which has increased the risk of market crashes. Using the Hidden Markov Model (HMM), this paper develops a new dynamic quota adjustment scheme that can rapidly reduce the risk of quota supply by bridging quota price and quantity with price feedback as a response signal. To achieve this, we integrated the HMM algorithm and a two-step quota adjustment model by setting price thresholds and then connected the quota adjustment transition matrix and historical quota price. By comparing the MSR from 2013 to 2018, our scheme will help mitigate risks in quota price because the HMM can show the actual impact of price feedback on quota adjustment with merits of steady quota price and timely supply optimization. Moreover, our scheme, which recalculates the transition matrix, can be applied in other mature carbon markets.

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Availability of data and material

We declare that all materials described in this manuscript, including all relevant raw data, are freely available to any researcher who hope to use for non-commercial purposes, without breaching participant confidentiality.

Code availability

Some or all data, models, or code generated or used during the study are available from the corresponding author by request.

Abbreviations

HMM:

Hidden Markov Model

CEQ:

Carbon emission quota

MSR:

Market stability reserve

ETS:

Emission trading scheme

ERF:

Emission reduction fund

RGGI:

Regional greenhouse gas initiative

CR:

Containment reserve

TNQC:

Total number of quota in circulation

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Acknowledgements

We thank the funds sponsored by the Major Program of the National Natural Science Foundation of China(Grant No. 71991474), the Foundation for Innovative Research Groups of the National Natural Science Foundation of China(Grant No. 71721001), the China Postdoctoral Science Foundation funded project(Grant No. 2021T140758), the National Social Science Foundation of China (20CGL036), the Science and Technology Planning Project of Shenzhen (JCYJ20190806144415100) and the Ministry of education of Humanities and Social Science project (Grant No. 20YJC630123).

Funding

This paper is supported by the Major Program of the National Natural Science Foundation of China (Grant No. 71991474), the Foundation for Innovative Research Groups of the National Natural Science Foundation of China (Grant No. 71721001), the China Postdoctoral Science Foundation funded project(Grant No. 2021T140758), the National Social Science Foundation of China (20CGL036), the Science and Technology Planning Project of Shenzhen (JCYJ20190806144415100) and the Ministry of education of Humanities and Social Science project (Grant No. 20YJC630123).

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Authors and Affiliations

  1. School of Business, Sun Yat-sen University, Guangzhou, China

    Yin Li

  2. Department of Finance, Southern University of Science and Technology, Shenzhen, China

    Zhongfei Li

  3. School of Economics and Management, Harbin Institute of Technology (Shenzhen), Shenzhen, China

    Jingjing Jiang

  4. Business School, Jiangsu Normal University, Xuzhou, China

    Yazhi Song

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  1. Yin Li
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  2. Zhongfei Li
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Contributions

YL contributes to organizing the whole structure and writing this paper. ZL contributes to the overall supervision and language review. JJ contributes to designing models, and revising. YS contributes to collecting the data and organizing empirical tests.

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Correspondence to Yazhi Song.

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Li, Y., Li, Z., Jiang, J. et al. Coping with the liquidity crisis: a new dynamic quota readjustment scheme for carbon markets. Environ Geochem Health 44, 3035–3055 (2022). https://doi.org/10.1007/s10653-021-01199-0

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