Diversification and hedging strategies of green bonds in financial asset portfolios during the COVID-19 pandemic

Abstract

In this paper, we investigate whether investors can reap potential diversification or hedging benefits from holding green bonds in a portfolio containing a conventional financial asset during the COVID-19 pandemic. Using data from 6 November 2014 to 5 November 2020, we estimate corrected dynamic conditional correlation between between green bonds and four major asset classes: stocks, corporate bonds, commodities, and clean energy. We extend our analysis by using these correlations to examine hedging, optimal portfolio weights, and naïve strategies and evaluate their implications for investors by calculating hedging effectiveness and utility gain improvement. Results reveal that across the full sample, pre-COVID-19, and during-COVID-19 periods, optimal portfolio weights represent an ideal strategy to realize the greatest risk reduction and risk-adjusted return. Further, green bonds could add substantial diversification benefits for investors holding assets in clean energy, global stocks, and commodities.