Evolutionary Path of Carbon Finance and Carbon Market: A Comprehensive Analysis

IV. Design, Pricing, and Price Prediction of Carbon Financial Instruments

Firstly, carbon financial instruments, like other financial instruments, can be divided into primary products and derivative products. The primary trading product in carbon finance is carbon emissions rights, and there are various types of derivative products, such as carbon futures (Chevallier 2009; Evans and Karvonen 2014; Creutzig 2016), carbon forwards (Andrews 2021), carbon options (Viteva et al. 2014; Liu and Huang 2021), and carbon swaps (Kanamura 2016). The sustainable development of carbon finance relies on the support of carbon financial instruments, and continuous innovation of carbon financial products contributes to the improvement of the carbon financial system.

Secondly, carbon pricing mechanisms are crucial in balancing supply and demand in the carbon financial market and are key components of carbon market mechanisms. Carbon pricing mechanisms include carbon taxes (Klenert et al. 2018; Muhammad 2022), carbon emissions trading systems (ETS) (Narassimhan et al. 2018; Rontard and Hernandez 2022), carbon credit mechanisms (Kale et al. 2009), result-based climate finance (RBCF) (Group et al. 2017), and internal carbon pricing (Zhu et al. 2022b).

Finally, carbon emissions are a significant factor causing environmental pollution and climate change, and the efficient operation of the carbon emissions trading market promotes carbon emission reduction. Accurate prediction of carbon prices is essential for the management of carbon trading markets, policy formulation, and investor decision-making. In carbon price prediction, researchers focus on improving the accuracy and stability of carbon price predictions. They have proposed various carbon price prediction models, such as the deep neural network model TCN-Seq2Seq (Zhang and Wen), the carbon price prediction hybrid model based on quadratic decomposition and improved extreme learning machine (ELM) (Zhou and Wang 2021a), the GARCH-LSTM hybrid model (Huang et al. 2021), and the quadratic decomposition carbon price prediction model optimized by the Sparrow search algorithm-based kernel extreme learning machine (Zhou and Wang 2021b), among others.

4 Evolutionary Path of Carbon Finance and Carbon Market

4.1 Analysis of Timeline

To analyze the evolutionary path of carbon finance and the carbon market, this study uses a timeline graph to explore the development of research hotspots in carbon finance and the carbon market over time. The keyword timeline graph shows the emergence time of hotspots on the horizontal axis and clusters of research topics automatically generated by the software on the vertical axis. Each node represents a research topic, and the size and color of the circles represent the richness of the corresponding topic, while the connections represent the relationships between different topics. From the graph, we can see that the keywords related to carbon finance and the carbon market are relatively concentrated in two time periods. This is because the United Nations Framework Convention on Climate Change and the Kyoto Protocol were signed in 1992 and 1997, respectively, which led to extensive academic attention to carbon finance and the carbon market. Additionally, after the Kyoto Protocol came into effect in 2005, a new wave of research on carbon finance and the carbon market emerged.

Figure 7 Timeline Graph of Carbon Finance and the Carbon Market

4.2 Analysis of Keyword Emergence

Keyword emergence refers to keywords that experience a sudden increase in frequency. It can identify keywords that have a significant increase in frequency within a certain period and demonstrate the research frontier and development trends of a specific discipline (Mathioudakis and Koudas 2010). In this study, a total of 225 emergent keywords were obtained using the keyword emergence function in Citespace, and 35 keywords were selected through manual screening, as shown in the table below. Firstly, in terms of the intensity of keyword emergence, the keywords with high emergence values are: kyoto protocol (43.54), climate change (33.58), carbon sequestration (25.09), clean development mechanism (24.64), carbon tax (15.9), energy policy (14.78), and carbon market (14.01). Secondly, the chronological order of keyword emergence reflects to some extent the evolution of research on carbon finance and the carbon market: policy formulation - establishment of carbon market systems - improvement of carbon market mechanisms.

Table 4 Keyword Emergence Table of Carbon Finance and the Carbon Market

4.3 Summary of Evolutionary Path

The timeline graph and keyword emergence table can reflect the evolutionary path of carbon finance and the carbon market to a certain extent. Combining with Table 1, the evolutionary path of carbon finance and the carbon market from 1992 to 2022 can be divided into the following three stages:

1. Initial development stage (1992-2012)

Around the 1990s, climate change became a major topic of discussion and concern worldwide. Carbon finance and the carbon market entered the initial development stage, which can be roughly divided into two periods. The first period focused on reaching a consensus on carbon emission reduction among countries and establishing corresponding climate policies. In 1992, the United Nations Framework Convention on Climate Change was established as an international treaty with the goal of stabilizing greenhouse gas concentrations in the atmosphere at a level that would prevent dangerous anthropogenic interference with the climate system. In 1997, the Kyoto Protocol was signed, aiming to limit greenhouse gas concentrations in the atmosphere. Following the global consensus on carbon emission reduction, carbon markets began to emerge in various countries. For example, the European Commission created the EU Emissions Trading System (EU-ETS) in 2005, which has become the world's largest carbon emissions trading mechanism. Although the United States and Australia had not ratified the Kyoto Protocol at the time, with Australia only becoming a signatory in 2007, both countries had regional and individual state-level participation in carbon emission trading programs. The Chicago Climate Exchange trading system was established in 2003, becoming a leading global organization and market for greenhouse gas emissions and promoting emission reductions. New Zealand and Japan subsequently launched their carbon markets in 2008 and 2010, respectively.

2. Stable development stage (2013-2019)

During this stage, the Doha Climate Change Conference in 2012 confirmed the second commitment period of the Kyoto Protocol from 2013 to 2020. In 2015, the Paris Agreement outlined how to address climate change beyond 2020, marking a significant change in international climate governance. In 2016, over 170 countries worldwide signed the Paris Agreement, leading carbon finance and the carbon market to enter a stable development stage. In the Asia-Pacific region, China established eight pilot carbon trading areas between 2013 and 2016, and South Korea established its carbon market in 2015. Kazakhstan in Central Asia and Quebec, Nova Scotia, and Massachusetts in North America also successively implemented carbon trading. During this stage, mature carbon emissions trading markets, such as the EU Emissions Trading System and the Chicago Climate Exchange, underwent a continuous process of summarizing and improving their carbon trading policies and systems. However, countries with newly established carbon markets, with China as a representative, started carbon trading from local pilot projects with a limited range of products. They are gradually building complete carbon trading policy and institutional systems.

3. Rapid development stage (2020-present)

In recent years, climate disasters such as extreme weather events, severe droughts, and large-scale wildfires have become increasingly frequent, making humanity experience the growing impact. Mitigating climate change and controlling greenhouse gas emissions have become urgent, and countries' development of low-carbon economies is crucial. In 2021, the Conference of the Parties (COP26) of the United Nations Framework Convention on Climate Change finalized the remaining negotiations on the implementation guidelines for the Paris Agreement, laying the foundation for the agreement's comprehensive and effective implementation. Following this conference, over 100 countries have submitted new climate pledges (Tollefson 2021). As of October 2021, 137 countries globally, representing over 70% of global carbon emissions, have made carbon neutrality pledges, most of which follow the “net-zero carbon” principle. With these commitments made, countries are actively taking corresponding measures. Notably, China's announcement of the 'dual carbon' goals at the 75th United Nations General Assembly in 2020 has sparked a surge in research on carbon finance and the carbon market in academia. Carbon emissions trading, as an effective measure for low-carbon economic development, has attracted widespread attention from all sectors of society, and the development of carbon finance and the carbon market has entered a strategic opportunity period, entering a rapid development stage. The primary tasks of this stage are to further improve carbon pricing mechanisms, carbon trading mechanisms, and regulatory mechanisms to create a highly efficient carbon market system and achieve a rich diversification of carbon financial trading products.