Volatility transmission in the CO2 and energy markets

The main consequence of the launch, in 2005, of the European Union Emission Trading Scheme (EU ETS) has been the establishment of a price for carbon emissions. Thus, major energy producers in Europe are now aware of the impact of their polluting activities. The interest in analysing the carbon markets from a financial point of view has exponentially increased since the launch of the EU ETS. However, no research articles have focused their attention on the volatility transmission between CO₂ and energy markets. The aim of this paper is to fill this gap in the literature. Specifically, our particular interest is to examine whether or not conditional volatility is transmitted across those markets since the start the EU ETS. We consider not only non-linearity in the variance of each series but we also allow for the possibility that changes in volatility in one of the markets may spill over to the others. The results show that CO₂ is directly affected by its own volatility, and directly and indirectly (through the covariance) affected by the oil and natural gas volatility. Additionally, shocks originated in the CO₂ and oil markets have an impact on CO₂ volatility. Finally, the behaviour of oil volatility is similar to CO₂ volatility in what concerns volatility transmission but this is not the case for natural gas volatility.