Risk-return relationship and structural breaks: Evidence from China carbon market

Abstract This paper investigates the risk-return relationship of China carbon market by evaluating the risk compensation coefficients, especially to consider the structural breaks caused by the policy uncertainty and vital events would impact the investment and carbon market risk-return relations. In detail, we have constructed the time varying GARCH-M model to depict the characteristic of risk compensation coefficient in China carbon market, then adopted ICSS algorithm to investigate the structural breaks in the carbon market returns and measured their impacts on the risk compensation coefficients. Particularly, we have evaluated the asymmetry effects of positive and negative structural breaks to the market risk-return relationship. Therefore, we find the risk compensation coefficients of carbon markets are obviously time varying, heterogeneously influenced by return demand of the inherent risk, risk compensation and unexpected return of the upfront period. Besides, the structural breaks significantly affect and make asymmetry effects to the risk-return relationship. Last, the findings are helpful for policy making of the carbon market development and market participants to avoid risks and optimize portfolios.