Testing for Linear and Nonlinear Granger Causality between the Carbon Spot and Futures Prices

The pricing of carbon allowance has gained wide attention from practitioners, economists and policy makers in recent years. Our paper constitutes the first exercise to employ nonlinear Granger causality test to examine the role of price discovery through the empirical relationship between EUA/CER spot price and futures price. We conduct our analysis in a comparative way by using both the Granger (1969)'s Granger causality test and the Hiemstra and Jones (1994)'s nonlinear Granger causality test. The results from linear Granger causality test show evidence of unidirectional causality from EUA spot price to the EUA futures price. In contrast, the results from nonlinear Granger causality test show significant bidirectional causality between futures price and spot price in both EUA and CER markets.