Research on the risk spillover effect between China’s national carbon emissions trading market and crude oil futures market

by XueRong Bai, Yan Chen, Fan Yang

The development of China’s National Carbon Market has strengthened the inherent link between the carbon market and the broader energy market, providing a potential for cross-market risk transmission resonance. Studying the risk spillover effects between China’s National Carbon Market and the crude oil futures market is of significant practical importance, both in terms of carbon market development and carbon risk management. Based on the Maximal Overlap Discrete Wavelet Transform (MODWT), the price series are decomposed across multiple scales, and the risk spillover effects between the carbon market and the crude oil futures market are examined from both the time domain and the frequency domain. Methods such as wavelet energy decomposition, wavelet correlation, lead-lag analysis, and wavelet coherence are used to explore the mean spillover effects and volatility spillover effects (collectively referred to as risk spillover effects) across various scales. The study finds that China’s National Carbon Market exhibits a clear compliance-driven effect, with relatively low market liquidity. The crude oil futures market experiences frequent price fluctuations, primarily driven by long-term factors. In the time domain, the risk transmission resonance between the carbon market and the crude oil futures market is high, with significant positive correlations observed at the D1 to D4 scales, and noticeable mean spillover effects. In the frequency domain, at the D3 to D4 scales, the carbon market and the crude oil futures market exhibit similar volatility frequencies, indicating strong volatility spillover effects. Based on these findings, it is recommended that the trading volume of the carbon market be gradually increased to improve market liquidity. Furthermore, the risk monitoring and early warning mechanisms of China’s National Carbon Market should be improved. For carbon-emitting companies, enhancing awareness of carbon asset management and making informed investment and hedging decisions based on the correlation between the two markets is crucial.