Analyzing Dependence Structure Between Carbon Market and Energy Commodities: Evidence from Copula Approach

Abstract

This paper uses copula models to examine the tail dependence behavior of the carbon market and energy commodities. We have taken daily data of the European Union Allowance (EUA) and four energy commodities. The crude oil and coal with more carbon emissions strongly depend on EUA, whereas natural gas and ethanol, which are comparatively cleaner energy sources, are weakly correlated to EUA. Moreover, the results indicate that the dependence and Kendall's tau correlation of EUA increase during the crisis period with all energy commodities except ethanol, which decreases. The relationship of EUA, however, is insignificant with natural gas. The low or weak correlation at the time of market downturns provides diversification benefits. The findings are helpful for investors in risk management and policymakers for devising regulations for the emission trading market for energy markets diversified by the carbon market.