Hedging strategies for U.S. factor and sector exchange-traded funds during geopolitical events

Abstract

Employing TVP-VAR analysis, this study examines risk transmission between factor and sector ETFs during the Russia–Ukraine and Israel–Hamas conflicts. We then identify effective post-conflict hedging strategies. Our analysis reveals a moderate post-conflict increase in ETF interconnectedness, suggesting heightened interdependence during geopolitical turmoil. Size, quality, and momentum factors serve as the main post-conflict risk transmitters, while the energy and basic materials sectors become the main recipients. Notably, the energy sector emerges as the most cost-effective post-conflict hedge. Additionally, size and quality factors demonstrate significant effectiveness in mitigating risk, while the communications sector shows a notable post-conflict improvement in hedging effectiveness.