Connectedness and Hedging Perspective Among the Clean and Fossil Energy

Abstract

In this chapter, the interactions and hedging performances of clean energy indices in Asia, Europe, and the USA as well as the West Texas Intermediate (WTI) crude oil are established with the utilization of a time-varying parameter vector auto regression (TVP-VAR) model. The results of the analysis show that clean energy is strongly self-driven particularly in Asia with a variance of 81.29% supplemented by Europe contributing to 14.17%, USA to 2.52%, and WTI to 2%. On the other hand, the clean energy index of the USA has considerable impact on others as evidenced by the fact that it is the main driver of the market, contributing to 28%. USA account for the largest percentage of the total variance (25%) followed by Europe with 17.05% and Africa with 8.27%, while Asia has the least percentage of the total variance (14.13%). Coupled with this is the fact USA and Europe are a net transferor with a score of 2.47 and 3.45, respectively. This shows that these regions influence Asian region significantly; on the contrary, Asia and WTI are a net volatility receiver with a score of-4.58 and-1.33, respectively. We establish substantial connectedness in between these markets via the parameters cTCI and total connectedness (TCI) with scores of 28.41 and 21.31, respectively, indicating notable connectivity. Portfolio strategies were also analyzed and it was concluded that employment of minimum variance portfolio (MVP) would be more effective due to higher portfolio stability with relatively low risk; therefore, the areas of interest should be focused on clean energy investments in Europe and Asia. Mean conditional portfolio (MCP) displays higher volatility levels in large measure and has fatter tails that convey wider return differentials uniformly across assets. The mean conditional optimized portfolio (MCoP) has a near-balanced equity growth, as the USA and WTI have effectively diversified away risk notwithstanding the values of negative hedge efficiency for Asian and European portfolios. Spikes and drops that can be noted in it are connected to the situation that occurred in 2014 with oil prices and the COVID-19 pandemic, while the data after the beginning of 2020 proved its stability. While trying to assess the portfolio that earn a better return, two panels were created. The panel within the WTI was excluded; its Sharpe ratio was higher compared to portfolio within the WTI. The Sharpe ratio suggest greater risk-adjusted returns of clean energy portfolio. Among hedging strategies, MVP performance gives the best hedging option compared to others. MCP showed the greatest improvement, emphasizing the benefits of focusing on clean energy assets, while MCoP highlighted the value of reducing interconnectedness within clean energy investments. This comprehensive analysis underscores the critical role of clean energy investments and strategic allocation in managing systemic risks and enhancing portfolio performance in the evolving global energy market.