The asymmetric effects of European carbon emission trading system on European stock market returns: The moderating role of oil price uncertainty

The first objective is to examine the asymmetric impact of European Union carbon emission trading system (EU-ETS) and oil price uncertainty (OPU) on the quantiles of European equity market returns. After confirming nonlinear dynamics in the daily time-series data for EU-ETS, OPU, and European stock returns, we use the quantile-based autoregressive distributive lag (QARDL) model. The second objective is to analyze OPU's moderating impact on dynamic conditional correlations (DCCs) and asymmetric dynamic conditional correlations (ADCCs) between EU-ETS returns and European equity market returns. To extract DCCs and ADCCs between carbon and stock returns, we employ the DCC-EGARCH and ADCC-EGARCH approaches with a range of robustness diagnostics. Thirdly, we utilize the hedge ratio and optimal portfolio weight selection approaches, guided by the DCC-GARCH-t copula method, to examine the hedging effectiveness (HE) against long-term OPU shocks through short-term positioning in European financial market returns and EU-ETS returns. Overall findings reveal asymmetric spillovers in extreme conditions, negatively affecting Belgian and Spanish firms in the long term due to EU-ETS-induced price increases. Long-term investors are advised to consider reallocating investment funds to the stock markets that are favorably impacted by EU-ETS fluctuations (Finland, France, Germany, Ireland, Italy, and the Netherlands) to achieve optimal gains during bullish equity market trends. However, simultaneous short-term negative OPU effects are observed in all economies' stock markets at all quantiles. The results also underscore OPU's moderating impact on stock‑carbon conditional connectedness, emphasizing the need for fund managers to acknowledge OPU as a moderating risk factor for carbon-stock hedging effectiveness.