Common volatility shocks of ESG markets

Abstract

This dissertation explores the interconnectedness and common volatility shocks in international ESG markets. Utilizing the MSCI ESG Leader Indices across eight regions, the study investigates whether idiosyncratic volatilities are correlated and identifies events triggering simultaneous movements. By employing the common volatility model proposed by Engle & Campos-Martins (2023), the research measures shared volatility shocks and their drivers, particularly focusing on climate policy uncertainty and transition and physical risks. The results show significant correlations between regional volatilities and identify key events that have caused the highest levels of volatility co-movement. The model also has portfolio implications, as regions have different exposures to the common factor. The most sensitive to volatility shocks are ESG market leaders such as Europe and the US, so emerging ESG markets such as Australia and Korea may be more attractive to risk-averse investors during periods of high ESG common volatility. Additionally, regression analysis shows that climate risks significantly influence these volatility shocks after controlling for global equity market shocks, highlighting the heightened sensitivity of ESG markets to climate dynamics after the Paris Agreement. Uncertainty surrounding climate policy and concerns about climate-related physical risks amplify shared volatility shocks in responsible markets. In contrast, shocks to climate transition risk exhibit a negative relationship with the factor, suggesting reduced exposure within the context of transitioning to a low-carbon economy. These findings provide novel insights for investors and policymakers, highlighting the importance of a stable regulatory environment and the role of ESG assets in the transition to a low-carbon economy.

Date of Award	30 Jan 2025
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Susana Campos Martins (Supervisor)