Volatility Connectedness between Clean Energy Firms and Crude Oil in the COVID-19 Era

Matteo Foglia,Eliana Angelini

doi:10.3390/su12239863

Abstract

The work investigates the volatility connectedness between oil price and clean energy firms over the period 2011–2020 (including the COVID-19 outbreak). Using the volatility spillover models, and dynamic conditional correlation, we are able to identify the volatility spillover effect between these financial markets and its implications for portfolio diversification. The results indicate a significant change in both static and dynamic volatility connectedness around the COVID-19 outbreak. For instance, total connectedness index changes from 21.36% (pre-COVID-19) to 61.23% (COVID-19). This finding shows the strong effect of the COVID-19 pandemic on these financial markets. Furthermore, we show how the WTI oil from the volatility transmitter (before the outbreak of the pandemic) becomes a risk receiver after the start of the global pandemic COVID-19. Our findings indicate that recent pandemic intensified volatility spillovers, supporting the financial contagion effects. Finally, we determine the optimal hedge ratios and portfolio weights. The estimates provided suggest the need for active portfolio management, taking into account the distinct characteristics of each sector and thus, the firm. For example, the optimal weight analysis shows how the clean sector has become important in optimal diversification strategies. Our results can be used for portfolio decisions and regulatory policymaking, particularly in the current context of high uncertainty.

Highlights

The relationship between the oil market and the clean energy market has been attracting the attention of politicians and economists in recent times
Our results point out that the cost of using oil as a hedging instrument for clean energy stocks is variable over time
Our research aims to study of the volatility spillover between oil price and major clean energy firms, in order to understand the dynamics within the sector and to implement optimal diversification strategies, in the current context of high uncertainty due to the COVID-19 outbreak

Summary

Introduction

The relationship between the oil market and the clean (renewable) energy market has been attracting the attention of politicians and economists in recent times. The spillover effects of volatility between oil and the clean energy market have become more crucial due to uncertainty in financial markets. Events such as the COVID-19 pandemic can act as a catalyst for contagion [20,21]. An increase in oil prices leads to an increase in the use of renewable energy, increasing profits. To study the price volatility spillover between these financial markets is fundamental to build optimal diversification (trading and hedging) strategies and to formulate regulatory policies [2,6], especially in the current context of sustainable development of energy sources

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Conclusion