Analysis of carbon trading market investigates flow of information to clean energy stocks

As climate change has emerged as one of the biggest global challenges of the 21st century, creative solutions have emerged in all aspects of society. Carbon emission trading, which monetizes pollution and gives polluters an incentive to reduce their emissions, is one increasingly popular approach to help combat climate change. While the carbon market is thought to have significantly impacted the development of clean energy industries, it is unknown how it continues to affect stock prices for clean energy firms.

Gao et al. studied how information flows from the international carbon trading market to renewable energy stocks by using methods commonly employed to analyze complex nonlinear and non-stationary systems, which are widely used in physics, oceanography, meteorology, medical treatments and financial engineering.

The researchers analyzed a decade of daily futures returns from the European Union Emissions Allowance, which gave carbon emission prices. They compared these with daily spot prices from the S&P Global Clean Energy Index as a proxy for clean energy prices. Using wavelet decomposition, transfer entropy and complex networks, they found the information flows on multiple timescales. While there is significant information flow from the carbon market to the clean energy prices from two to 16 days, the flow is most stable from four to eight days.

“The findings arising from this study could help clean energy companies make the best response to market changes,” said author Mei Sun. “Furthermore, financial investors might use the information provided in the carbon trade market to predict the volatility of clean energy stock returns.”

Ultimately, these findings can help policymakers set reasonable carbon prices to help stimulate the development of clean energy.

Source: “Multiresolution analysis of information flows from international carbon trading market to the clean energy stocks market,” by Anna Gao, Mei Sun, Dun Han, and Chunyu Shen, Journal of Renewable and Sustainable Energy (2020). The article can be accessed at https://doi.org/10.1063/5.0022046 .