Impact of energy sector volatility on clean energy assets

Abstract

We study the effect of uncertainty in energy sector firms on clean energy exchange traded funds (ETFs). In doing so, we use the information on energy sector implied volatility index (VXXLE) to reflect the risk or uncertainty of energy sector firms. Unlike the existing literature that mainly employs linear models to study the association between clean energy and financial markets, we apply Markov regime switching models to uncover how clean energy ETFs react to volatility shocks in the energy sector market during high and low volatility regimes. Our findings reveal a negative effect, suggesting that when implied volatility levels are high for energy sector firms a drop is likely to be observed in clean energy asset returns. The results also show evidence of an asymmetric effect. During the high volatility regime, the association between energy sector volatilities and clean energy ETFs holds stronger compared to the low volatility regime. We further document that changes in the levels of VXXLE substantially impact the realized volatility of these ETFs. Our findings offer significant implications to investors and policymakers.