Dynamic linkages and spillover effects between CET market, coal market and stock market of new energy companies: A case of Beijing CET market in China

Highlights

• There are significant time-varying correlations and long-run persistence of shocks to the DCCs between three markets.

• There is a bi-directional volatility spillover between the coal market and the new energy stock market.

• The optimal weight is 82.65% for new energy stock and 17.35% for coal.

• The optimal hedge ratio is 17.34% for new energy stock and 49.98% for coal.

Abstract

Chinese energy consumption structure has been dominated by coal for a long time, which makes China facing serious environmental problems. To achieve the target of CO2 emission reduction, a carbon emission trading (CET) market and promoting the development of new energy should be worthy choices. The issues of dynamic linkages and spillover effects between the CET market, the coal market and the stock market of new energy companies (NEC) are important topics for studies. The paper applies a VAR(1)-DCC-GARCH(1,1) model and a VAR(1)-BEKK-AGARCH(1,1) model to obtain the following conclusions: (1) There exists significant time-varying correlations and long-run persistence of shocks to the DCCs between Beijing CET market, the coal market and the stock market of NEC, and the coal market and the new energy stock market have higher volatility persistence; (2) There is a bi-directional spillover effects between the coal market and the stock market of NEC, which is consistent with the results of the Granger causality; (3) The optimal weight is 82.65% for new energy stock and 17.35% for coal. The optimal hedge ratio is 49.98% for coal, while the optimal hedge ratio is 17.34% for new energy stock.

Introduction

Chinese energy consumption structure has been dominated by coal for a long time, which makes China facing serious environmental problems. According to the BP's data on China in 2016, the consumption share of coal, oil and natural gas accounted for 61.8%, 19%, and 6.2%, respectively, while non-fossil energy consumption accounted for 13%. Although Chinese government makes effort to achieve the goal of the ratio of natural gas and non-fossil energy consumption increased to about 15% and 20% in 2030 in the Plan on the Revolution Strategies in Energy Production and Consumption (2016–2030), the proportion of coal consumption is still more than 50%. Coal will remain the most important fossil fuel energy in China in the future, and the coal market is also the most important component of China's energy market. In addition, the international community emphasizes on sustainable development of energy, climate, and the environment, which urges Chinese government to reduce dependence on coal. However, the energy pricing reform, especially, for fossil fuel is an effective way to control the total energy consumption and also to improve energy efficiency [1]. Consequently, Chinese government is determined to implement energy pricing reform for achieving the target of energy conservation and emissions reduction [2].

In order to achieve the target of CO2 emission reduction, promoting alternative energy development and reducing reliance on fossil fuel energy, building a carbon emissions trading (CET) market is a good approach [[3], [4], [5]]. The National Development and Reform Committee (NDRC) published the Notice on Effective Implementation of the National Carbon Emissions Trading Market to Start (Climate [2016] NO. 57) in 2016, and announced that national CET market would be carried out in 2017 [6,7]. After 2013, there were CET pilots in eight provinces and cities: Shenzhen, Beijing, Tianjin, Shanghai, Chongqing, Guangdong, Hubei and Fujian. By July 14, 2017, the cumulative trading volumes in eight pilots were close to 118 million tons, and the total turnover in eight provinces and cities reached over 2.58 billion CNY. Nevertheless, the grandfathering rules which focus on historical emissions lead to excessive allocation and low carbon price [8]. The prices of CET pilots are far lower than 100 CNY/ton and fluctuates significantly [9]. Consequently, a relatively sustained and completed CET scheme in China is likely to bring greatly national and global benefits in the long term [10], which also helps to realize the function of emission reduction and stimulation of the new energy development [11].

Over the past decade, new energy has developed rapidly and has become a significant factor that whether or not China can successfully reduce dependence on fossil fuel energy and realize the target of emission reduction [12]. The development of new energy is of great significance to speed up the changes of the mode of economic development, and the new energy has become one of the strategic emerging industries in China. The rapid development of the new energy industry has also drawn the attention of investors in the capital market, namely, the stock market of new energy companies (NEC). Additionally, Kortum and Lerner [13] indicated that risk capital investment is 3–4 times more effective than R&D for promoting new energy development. Therefore, understanding the financial mechanism behind new energy has practical significance. However, the main business of new energy companies contains not only new energy but also related technologies, equipment and applications. In this paper, new energy companies are composed of 70 companies listed on the Shanghai Stock Exchange Composite Index and Shenzhen Stock Exchange Composite Index, including fields like new energy (including solar energy, wind energy, nuclear energy, biomass energy and hydrogen), new energy vehicle, the related storage technologies, cleaner energy technologies and equipment, energy saving technologies and equipment and so on.

China's CET market is a form of CET pilots and still in the initial stage with unreasonable carbon emissions trading price and imperfect carbon emissions trading mechanism. However, there may be dynamic conditional correlations and spillovers between CET market, coal market and stock market of NEC in China. With the development of three markets, these relationships and spillovers will be more obvious. According to these relationships, the government policy makers and investors can make strategic decisions in advance. In addition, there is little research which studies the dynamic conditional correlations and spillover effects for three markets in China. Thus, how is the dynamic relationship between CET market, coal market and stock market of NEC in China? Is there any volatility spillover effect between them? If there are spillover effects, how should we achieve the portfolio optimization, optimal risk management, and hedging strategies? The remainder of this paper is as follows: Sections 2 briefly presents the existing studies. Section 3 constructs the VAR-DCC-GARCH model and VAR-BEKK-AGARCH model. The description of the data on CET market, coal market and stock market of NEC are presented in Section 4. In Section 5, we discuss the results, and calculate the optimal portfolio of each asset and the optimal hedge ratio according to the result of VAR-BEKK-AGARCH model. The last section concludes and provides policy suggestions.