Hedging climate and geopolitical risks in low- and lower-middle-income economies: Exploring the role of well-known and novel safe-haven indices

This study is the first to comprehensively investigate whether transition and physical climate risks (CRs) and disaggregated geopolitical risks (GPRs) transmit shocks to financial markets in low- and lower-middle-income (LLMI) economies, and whether there exist assets that can diversify such risks. We considered five CR and GPR indices, nine LLMI equity indices representing sixteen economies worldwide, and six potential hedge and safe-haven candidates. Using the time-varying parameter vector autoregressive model, we uncover that LLMI equities are receivers of shocks from both CRs and GPRs, including when they are jointly included in the network. We then employ a recently developed safe-haven index (SHI) by Baur-Dimpfl-Pena, three international S&P Global indices representing green bonds, clean energy transitions, and Shari'ah-compliant assets, two novel commodity and cryptocurrency indices (CMI and CCI) that we developed, and dynamic conditional correlation-based hedge and safe-haven regressions. The hedge and strong safe-haven roles of the candidate indices are found to be heterogeneous: Overall, SHI outperforms others, followed by CMI and CCI; however, against CRs, the safe-haven role of the clean energy transition index (CETI) is dominant, followed by CMI and CCI, which offer comparable benefits. Results from this study highlight the need for investors to carefully optimize their LLMI equity portfolios in relation to CRs and GPRs, and for policymakers to reinforce regional cooperation to mitigate climate and geopolitical risks.