How Interdependent are Energy and Carbon Markets? Evidence from a Quantile-on-Quantile Regression Approach

Abstract

We premise and model the dynamic interdependence between energy and carbon prices in Phase III of the European Union Emission Trading Scheme (EU ETS) in a heterogeneous impulse-response setting. Our research framework is based on the proposition that energy prices (e.g., oil, natural gas, and coal) would impact carbon prices negatively, but the impact magnitudes would be varied over the distribution of carbon and energy prices, having thus important policy implications. Applying a novel Quantile-on-Quantile (QQ) regression and the causality-in-quantiles approach, we show that the negative impacts are much stronger when carbon prices are at lower quantiles of the price distribution compared with that at the higher quantiles. In the face of different nature in energy price shocks, the asymmetric carbon price-response is an indication of the non-unique carbon market dynamics, the efficient management of which would require differentiated policy interventions. Robustness checks reassure the accuracy of our conclusions.