Effect of unpredictability in economic and energy policy on China's emission trading programme pilots' volatility

Abstract

The volatility of China's emission trading system (ETS) pilots is significantly influenced by economic policy uncertainty (EPU). This article examines how EPU affects the volatility of three typical ETS pilots in China—Hubei, Guangdong, and Beijing—using two local and two global EPU indexes as proxies based on the GARCH-MIDAS model. The study reveals notable differences in the impacts on volatility between the ETS pilots and EPU indexes. For instance, a 0.01 unit increase in the weighted growth rate of EPU results in a long-term volatility increase of 9.371%–28.777 % for the Hubei ETS and 1.629%–5.444 % for the Beijing ETS. In contrast, in Guangdong, the volatility rises by 11.926%–22.713 % in response to a rise in local EPU and falls by 38.302%–59.063 % in response to an increase in global EPU. Additionally, economic policy changes impact ETS pilots' production volatility by modifying industry output, although the carbon market's stabilization measures mitigate this impact. The GARCH-MIDAS model with EPU indices demonstrates better out-of-sample prediction ability for the Hubei and Beijing ETS. This research provides investors with a reliable method for portfolio construction and offers significant policy implications for the government to stabilize ETS volatility.