Volatility spillover and hedging strategies among Chinese carbon, energy, and electricity markets

Abstract

There is an intricate relationship between the carbon, energy, and electricity markets, and it is essential to clarify the relationship between them to promote the sustainable development of the three markets. This paper focuses on Chinese carbon, energy, and electricity markets and uses the TVP-VAR model to explore the risk spillover effects among these markets. It also combines the QVAR model with the TVP-VAR model to assess the impact of COVID-19 on their connectedness. Additionally, an effective diversified portfolio is constructed to cope with inter-market risk spillover. The empirical testing is conducted using a sample of eight bellwether stocks from Chinese carbon, energy, and electricity markets, spanning from August 1, 2013, to December 30, 2022. Results show that: 1. Risk spillover among the three markets is particularly evident in the downside or upside market. 2. The carbon market and electricity market are the largest recipients and transmitters of net risk spillovers, respectively. 3. During COVID-19, the carbon market enhanced the spillovers on other markets under market downside periods. Our findings provide theoretical references for market participants and regulators to address inter-market volatility spillovers.