Sustainable Finance and Climate Risk: Evaluating the Role of Green Energy Assets

Abstract

Climate change is being viewed as a systemic cause of financial risk, which impacts on assets, portfolio allocation, and global financial system stability. Green assets and sustainable finance have received increased interest in this regard among policymakers and investors. But it is also not known whether popular Green Exchange-traded funds (ETFs) are actually indicative of climate and market risks hedging, or whether they act more like traditional high-beta equity exposures. The thesis answers that question, which is accomplished by studying the financial performance and the risk nature of four large clean-energy ETFs around the world (ICLN, TAN, CNRG and FAN) between the years 2018-2024, and through the analysis of their association with climate policy uncertainty.The empirical study will use daily data of 1,522 trading days. The prices of ETFs, worldwide and upcoming equity standard (ACWI, EEM, BKF) and gold (GLD) are transformed to log returns and consequently excess returns with the help of the 3-month U.S Treasury bill rate (DTB3) as the proxy of the riskless rate. The China Climate Policy Uncertainty (CCPU) index, the news-based measure of climate policy risk, is used to measure climate policy risk on one of the major emitting nations in the world. The empirical approach is premeditatedly straightforward and narrow. To describe the risk-return profile and co-movements of green ETFs and equity benchmarks and gold, first, the descriptive statistics and correlation matrices are employed. Second, the hedge and safe-haven regressions, according to Baur and Lucey (2010) and Baur and McDermott (2010), are estimated to determine whether the green ETFs hedge global and emerging equity markets or are safe havens in times of hard economic times. Third, regression of markets using a market model augmented with the standardised CCPU index is implemented to determine the independent impact of daily policy uncertainty in climate policy on the excess returns of green ETFs when global equity movements have been adjusted.The findings indicate that clean-energy ETF are significantly more unstable than the world stock standard and display stronger negative tail returns, its risk-adjusted performance is mostly lower than ACWI and in a few instances even lower than gold. The correlations and betas show the four green ETFs move in a very close pattern and fully committed to both global and emerging equity markets but gold has weak correlations with equities. As a result, green ETFs can never be considered as hedges or safe havens in the conventional sense of the term: the betas of the funds are positive and meaningful during normal conditions as well as during the state of crisis. Further, the statistically significant impact of CCPU index on excess returns that ICLN has is not significant even after considering the global market risk. Generally speaking, the results imply that clean-energy ETFs are currently functioning as pro-cyclical and high-beta equity sector exposures as opposed to being natural hedges against climate-related financial risk.