The role of climate policy uncertainty on the long-term correlation between crude oil and clean energy

Abstract

This study investigates how climate policy uncertainty (CPU) affects the long-term dynamic correlation between crude oil and various clean energy assets by using an improved DCC-MIDAS-CPU model. Specifically, we use the improved two-factor GARCH-MIDAS-RV-CPU model to analyze the long-term volatile components of the crude oil and clean energy markets, and demonstrate more superior performance than the single-factor GARCH-MIDAS model which is usually used in previous literature. Our findings support that climate policy uncertainty has a significant negative (positive) influence on the long-term clean energy (crude oil) market's volatility in general. Additionally, climate policy uncertainty negatively affects the relationship between crude oil and clean energy. Furthermore, we also reveal that the impact of CPU on the long-term relationship between crude oil and different sub-sectors of clean energy assets is heterogeneous. Finally, the risk management analysis shows that clean energy assets can efficiently diversify climate policy risk on oil assets by considering the influence of CPU. And Energy Storage (Developer Operator) is the optimal hedge (portfolio) instrument from the perspective of risk management, respectively.