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

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.