Climate bond, stock, gold, and oil markets: Dynamic correlations and hedging analyses during the COVID-19 outbreak

Abstract

Adverse ecological effects have recently generated several eco-friendly investment opportunities including green and climate bonds. Although climate bonds have emerged as an appealing investment, little is known about their dynamic correlations and market linkages with US equities, crude oil, and gold markets, especially during stress times such as the COVID-19 outbreak, which are essential for asset allocation and hedging effectiveness. In this paper, we report time-varying correlations between climate bonds and each of the markets considered, which intensify during the COVID-19 pandemic. On average, climate bonds are negatively associated with US equities and have a near zero correlation with crude oil, whereas they are positively associated with gold. There is a bidirectional volatility linkage between climate bonds and the three indexes under study, whereas return linkages are marginal. The hedge ratio is positive for bond-gold, whereas it switches between positive and negative states for bond-stock and bond-oil, especially it switches more extremely during the COVID-19 outbreak. Although climate bonds provide the highest risk reduction in a portfolio containing US equities or gold as a part of a hedging strategy, their hedging effectiveness is considerably reduced during the pandemic. The findings have implications for markets participants aiming to green their portfolios and make them robust during stress times, enabling a smooth and speedy transition to a low-carbon economy.