Dynamic volatility connectedness in the European electricity market

Since the 1990s, one of the energy policy objectives of the European Union (EU) has been to create a single, integrated European electricity market. This study uses a broad set of European electricity markets to answer the question whether volatility connectedness is higher in geographically closer markets or whether all markets are integrated. This question is particularly relevant now, at a time of high volatility of energy commodity prices, which can affect energy security in Europe. Our empirical analysis examines volatility connectedness in 26 European electricity markets between 1 August 2007 and 23 February 2022 using the time-varying parameter vector autoregressive model (TVP-VAR) based on the extended joint connectedness method (Balcilar et al., 2021). Furthermore, the impact of volatility of determinants of electricity prices on volatility connectedness in European electricity markets since 2016 is assessed.The results reveal that volatility connectedness between markets, i.e., the integration of European electricity markets, increases. Connectedness within geographically closer markets is observed mainly in the initial periods. However, since 2016, regional connections have increased, which is accompanied by interregional connections. This is particularly evident in the recent period -characterised by high volatility of electricity and energy commodity prices. However, when the impact of volatility of electricity price determinants on volatility connectedness is removed, especially since 2021, the results are slightly altered and indicate lower volatility connectedness in the European electricity markets. The role of the main net transmitters or net receivers does not change, while the role of the other markets changes or strengthens/weakens. Inter-regional connectedness is not as strong, which means that volatility connectedness occurs mainly in the markets from the same region.