An analysis of the time-varying causality and dynamic correlation between green bonds and US gas prices

Abstract

Using the GO-GARCH, ADCC, and DCC models, this study investigates the volatilities and conditional correlations between green bonds and US gas prices. Furthermore, we investigate the causality between the markets from 11th January 2013 to 8th September 2020 using Shi et al. (2018) time-varying causality and Breitung and Candelon (2006) frequency domain Granger-causality approaches. Hedge ratio results show that GO-GARCH has the highest hedging effectiveness for hedging green bonds with shale gas and natural gas. Natural gas appears to be the best hedge for green bond prices, according to estimates of hedging effectiveness. We find no significant Granger causality between green bonds and natural gas in the short- and long-term dynamics of the spectral Granger causality test, but we do find long-term Granger causality between green bonds and shale gas. We find strong significant bidirectional causal effects between green bonds and gas prices during bearish market conditions using the time-varying causality test. The evidence of a strong correlation between green bonds and shale gas and natural gas suggests that policymakers should consider both markets as interconnected in their policy formulation strategy. Furthermore, increasing the share of green bonds will undeniably support the transition to a low-carbon economy, fulfilling the promise of the Paris climate change agreement. Realizing the role of green bonds as diversifiers against the fluctuation of gas markets encourages portfolio investors who want to achieve higher investment performance to include green bonds in their portfolios.