Green Equities and Bonds Are Exposed to Climate and Geopolitical Risks

12:53, December 13, 2022

Scientists found out how instability affects environmental (green) investments

UrFU economists have determined how growing geopolitical tensions affect green equities (stocks) and bond markets. To this end, researchers measured geopolitical risks using threat and action indices. Economists applied two recently developed econometric analysis methods: the cross-quantilogram and quantile and quantile (QQ) approaches, to estimate the conditional and unconditional volatility spillovers considering short, medium, and long term. The results of the analysis are published in the journal Energy Economics. The study was supported by the grant of the Russian Science Foundation (Project "Empirical Modelling of Balanced Technological and Socio-Economic Development in the Russian Regions ", No. 19-18-00262).

"Geopolitical risks can influence green markets through two different channels. First, the geopolitical risk can influence the green markets through the indirect channel, which is mainly the hydrocarbon prices", explains Kazi Sohag, head of the Economic Policy and Natural Resources Laboratory at the Ural Federal University's Graduate School of Economics and Management. "Geopolitical risk also affects the crude oil market through the supply and demand channels. Rising oil prices should increase green investments through the substitution effect. In addition, the renewable or cleaner energies can substitute for dirty or carbon content energies".

The second channel is direct, through reduced economic activity, adds Kazi Sohag. According to the researcher, higher geopolitical risks adversely lead to lower asset prices and returns. Increasing geopolitical risks lead to a significant economic downturns due to their declining effects on international trade and global economic welfare. Thus, such prolonged geopolitical shocks and sluggish economic growth lead to a plunge in the equity returns, including green stocks.

In addition, researchers have found that geopolitical threats transmit a positive spillover to the green equity and bond markets, in both falling and rising markets. In other words, in a rising geopolitical threat environment, investors prefer green investments over dirty investments (fossil fuels) or other geopolitically exposed investments. This is the transmission of volatility through the first channel, what it means, through the substitution effect. Investors seek to diversify their portfolios using green stocks and bonds investments to hedge against potential losses due to anticipated increased volatility in the stock market.

On the contrary, the geopolitical acts negatively affect the green equity and green bond markets through the second channel as the beginning and escalation of the wars, and the terrorist acts adversely affect asset prices and returns. However, investors and portfolio managers benefit from buying green stocks and bonds during such periods because of their low value. Notably, the correlation between geopolitical risks and green markets is significant over the long term, unlike the traditional stock market.

"Empirical observations also confirm that green investments often act as a hedging decision during periods of increasing geopolitical risks. On the other hand, the investors should avoid investing in green equities and bonds when they are expensive and geopolitical tensions start to rise," adds Oleg Mariev, head of the Economics Department and leading researcher at the School of Management and Interdisciplinary Studies at UrFU.

Reference

The Geopolitical Risk Index is a new index developed by Caldara and Iacoviello (2018) that detects both the direct and indirect risks of geopolitical events by counting the occurrence of words related to geopolitical tensions in leading international newspapers. The Geopolitical Risk (GPR) index not only concentrates on terror attacks but also considers other forms of geopolitical tensions such as war risks, military threats and political tensions. The index includes sub-indices which considering the distinct categories of geopolitical events: the Geopolitical Threats Index focuses on the terrorist or military tensions, while the Geopolitical Acts Index subsumes the phrases related to the realization or the escalation of adverse events.  

The news article was translated by UrFU International Marketing Office
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