Connectedness and hedging strategies between European sustainability and conventional stock markets

There is an increasing move towards sustainable approaches to all aspects of industry, particularly in the energy sector, as a result of the need to limit greenhouse gas emissions. This has facilitated a move to sustainable investing and the rise of specific sustainable investment strategies. The aim of this paper is to analyze the connectedness between sustainability and conventional stock price returns of the main European countries (Europe, Belgium, France, Italy, the Netherlands, Spain, Finland, and Germany) using the time-varying parameter vector autoregression (TVP-VAR) model. In addition, we use the GARCH-DCC model to assess the optimal portfolio weights and hedging strategies. The results show strong dynamics and positive spillovers among the sustainability and conventional stock markets. The spillover size shows a significant jump during the pandemic outbreak, the 2016 Chinese stock market crash, Brexit, and the Ukraine-Russia tensions. During the pandemic, all conventional stock markets except Italy and Spain are net shock contributors, while all sustainability stock markets are net receivers except for France, Germany, and Europe. The results of the optimal hedge ratio reveals that the sustainability stock asset is an expensive hedge before and during the pandemic. The optimal weight values indicate that investors should hold more conventional stocks than sustainability stocks irrespective of the pandemic crisis. The Italian-sustainability stocks portfolio provides the highest hedging effectiveness before and during the COVID-19 period.