MODELLING VOLATILITY IN CARBON FUTURES MARKETS: A GARCH-MIDAS APPROACH WITH UNCERTAINTY INDEXES

The European Union Emissions Trading System is a platform that allows investors to buy or sell carbon emission allowances. Its goal is to help achieve decarbonization through the establishment of annual emissions caps with which companies must comply. This dissertation investigates the impact that various uncertainties indexes, namely the global economic policy uncertainty, the climate policy uncertainty and the geopolitical risk, have on the volatility of the carbon futures returns in the EU ETS. To assess that impact, the statistical model GARCH-MIDAS was employed. This specific model allows to associate high frequency variables, such as financial returns, with low frequency variables, such as macroeconomic variables. The results show that both global economic policy uncertainty and geopolitical risk have a positive correlation with the long-term volatility of the European carbon futures returns whereas climate policy uncertainty displays a negative correlation. This study can shed some light on the dynamics of carbon markets, helping policy makers and investors take better decisions regarding this peculiar market.