Risk spillovers between carbon prices and financial factors: evidence from the Chinese and the European Union carbon markets

Purpose This study investigates the risk spillover between various financial factors and carbon prices and compares the similarities and differences in risk spillover between the Chinese and the European Union (EU) carbon markets. Design/methodology/approach This study employs the quantile time-frequency connectivity approach to capture the short- and long-term risk spillovers between financial factors and carbon prices across different quantiles. Findings (1) In the Chinese and EU carbon markets, the carbon price is the net risk receiver and the largest net risk transmitters are the investor sentiment index (VIX) and the financial stress index (FSI). (2) Risk spillovers are mainly driven by short-term dynamics and increase abruptly in extreme cases. (3) Unexpected events exacerbate risk spillovers between financial factors and carbon prices and change the direction of net spillover from carbon prices. (4) The EU carbon market with a higher degree of financialization has stronger risk spillovers with financial factors than the China’s carbon market. Especially, when shocked by unexpected events, the EU carbon market can quickly absorb the impact of financial factors and eliminate fluctuations compared with Chinese carbon market. Originality/value Developing a new analysis framework of carbon prices provides a valuable reference for investors to construct diversified investment portfolio strategies. Comparing the significant financialization differences between Chinese and the EU carbon markets, we make recommendations for government regulatory agencies on risk prevention measures and the development of other emerging carbon markets.