The Dependence Structure Between Carbon Emission Allowances And Financial Markets - A Copula Analysis

This paper applies different copulas in order to investigate the complex dependence structure between EU emission Allowance (EUA) futures returns and those of other commodities, equity and energy indices. The analysis yields important insights into the relationship between carbon, commodities and financial markets. First of all, the authors find a significant relationship between EUA returns and those of the other considered variables that is most appropriately modeled by a Gaussian and Student-t copula. These results contradict some earlier studies that report no statistically significant or even negative correlations between returns of emission allowances and other financial variables. Secondly, considering time-varying copulas shows that the estimated copula parameters are not constant over time.