Dynamic volatility spillover effect analysis between carbon market and crude oil market: a DCC-ICSS approach

This paper applies the Dynamic Conditional Correlation (DCC) model and Iterative Cumulative Sums of Squares (ICSS) model to investigate the volatility spillover effect between carbon emission market and crude oil market. In particular, an effective time-varying correlation analysis method, i.e. DCC, is first conducted to capture the dynamic linkage relationship between the two markets. Then, the ICSS method is used to explore the structural changes of such spillover effect and further identify the impacts of the related events on the linkage mechanism. Using the European Union Allowance (EUA) futures price and Brent crude oil futures price as study samples, some interesting findings can be obtained from the empirical study: (a) there exists an obvious positive relationship between the EUA and Brent markets; (b) such dynamic spillover effect varies with time and becomes somewhat smaller in Phase III than Phase II and (c) economic events (e.g., the financial crises) and political changes would structurally change the dynamic linkage mechanism.