Connectedness and hedging strategies between European sustainability and conventional stock markets

There is a growing shift towards sustainability in industry, especially energy, to limit greenhouse gas emissions, leading to sustainable investment strategies. This study examines the connectedness between sustainability and conventional stock returns in major European countries using a time-varying parameter vector autoregression (TVP-VAR) model. The empirical results show strong dynamics and positive spillovers between sustainability and conventional stock markets, with significant spikes during the pandemic, the 2016 Chinese stock market crash, Brexit and Ukraine-Russia tensions. During the pandemic, conventional stock markets, except Italy and Spain, are net shock contributors, while sustainability markets, except France, Germany and Europe, are net receivers. The optimal hedge ratio indicates sustainability stock assets are costly hedges before and during the pandemic. Optimal weight values suggest investors should prioritize conventional stocks over sustainable ones, regardless of the pandemic. The Italian sustainability stock portfolio offered the highest hedging effectiveness before and during COVID-19.