How does the reserve currency (US dollar) affect the diversification capacity of green bond investments?

Abstract

The growing potential of green bond markets helps mobilize financial resources to green projects that significantly contribute to the Sustainable Development Goals (SDGs). Recent research suggests a time-varying dynamic relationship between green bond, conventional bond, stock, and energy markets. But, there is scarce information concerning the determinants of the relations between these markets. To fill this important gap, the dynamic conditional correlations (DCCs) between green bond, conventional bond, stock, and energy markets are first derived to explore the characteristics of the DCCs. Consistent with recent studies, the results indicate the higher DCCs of green bond returns with conventional bond returns in comparison with the DCCs of green bonds with energy commodity and stock markets. Then, the role of the US dollar on the DCCs is examined by accounting for uncertainty in global markets, monetary conditions, financial stress, and business cycles and utilizing the autoregressive distributed lag (ARDL) approach. The main findings demonstrate the crucial role of the rising US dollar in enhancing the DCCs between green and conventional bond markets. Contrary to this finding, we observe that the rising US dollar reduces the level of the DCCs of the green bonds with energy commodity and stock markets. Our results emphasize that the US dollar appreciations increase the diversification capacity of green bond investments for market players in energy commodity and stock markets. The implications of our analysis are valuable for environmentally-friendly investments and optimal asset allocation strategies in the energy and financial markets.