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How does carbon market react to economic policy uncertainty and oil price shocks? New evidence from a time-varying perspective

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  • Wang, Xiaoqing
  • Safi, Adnan
  • Wang, Su
  • Zhang, Yifei

Abstract

Ensuring the smooth operation of the carbon market mechanism is crucial to actively and effectively addressing global climate change. Economic policy uncertainty (EPU), crude oil market (OLP) and carbon price fluctuations (ECF) are intricately interconnected, yet the precise dynamic relationship among them remains elusive. Therefore, this study uses the time-varying parameter vector auto-regressive model with stochastic volatility to explore the time-varying effects of economic policy uncertainty and crude oil prices on the EU carbon market. The results underline that increases in EPU and oscillations in OLP lead to heightened volatility of carbon market in the short and medium term. The impulse responses of ECF to EPU and OLP shocks are most pronounced in the short run and gradually weakens with the increase of lag periods. Besides, the positive linkages show the time-varying characteristics. Moreover, economic policy uncertainty serves as a stronger driver of carbon price volatility, whereas the positive response of carbon market to oil price exhibits greater stability. Finally, the influences of EPU and OLP on ECF will be strengthened during periods of global public emergencies and extreme events. On this basis, the findings provide valuable implications for facilitating the smooth operation and efficacious risk management of carbon market.

Suggested Citation

  • Wang, Xiaoqing & Safi, Adnan & Wang, Su & Zhang, Yifei, 2026. "How does carbon market react to economic policy uncertainty and oil price shocks? New evidence from a time-varying perspective," International Review of Economics & Finance, Elsevier, vol. 105(C).
    • Handle: RePEc:eee:reveco:v:105:y:2026:i:c:s1059056025010044
    DOI: 10.1016/j.iref.2025.104841
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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy

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