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The Diversification Benefits of Including Carbon Assets in Financial Portfolios

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  • Yinpeng Zhang

    (School of Economics and Management, Beihang University, Beijing 100191, China)

  • Zhixin Liu

    (School of Economics and Management, Beihang University, Beijing 100191, China)

  • Xueying Yu

    (School of Economics and Management, Beihang University, Beijing 100191, China)

Abstract

Carbon allowances traded in the EU-Emission Trading Scheme (EU-ETS) were initially designed as an economic motivation for efficiently curbing greenhouse as emissions, but now it mimics quite a few characteristics of financial assets, and have now been used as a candidate product in building financial portfolios. In this study, we examine the time-varying correlations between carbon allowance prices with other financial indices, during the third phase of EU-ETS. The results show that, at the beginning of this period, carbon price was still strongly corrected with other financial indices. However, this connection was weakened over time. Given the relative independence of carbon assets from other financial assets, we argue for the diversification benefits of including carbon assets in financial portfolios, and building such portfolios, respectively, with the traditional global minimum variance (GMV) strategy, the mean-variance-OGARCH (MV-OGARCH) strategy, and the dynamic conditional correlation (DCC) strategy. It is shown that the portfolio built with the MV-OGARCH strategy far out-performs the others and that including carbon assets in financial portfolios does help reduce investment risks.

Suggested Citation

  • Yinpeng Zhang & Zhixin Liu & Xueying Yu, 2017. "The Diversification Benefits of Including Carbon Assets in Financial Portfolios," Sustainability, MDPI, vol. 9(3), pages 1-13, March.
    • Handle: RePEc:gam:jsusta:v:9:y:2017:i:3:p:437-:d:93470
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    3. Seyoung Park & Eun Ryung Lee & Sungchul Lee & Geonwoo Kim, 2019. "Dantzig Type Optimization Method with Applications to Portfolio Selection," Sustainability, MDPI, vol. 11(11), pages 1-32, June.
    4. Wei Jiang & Yanyu Zhang, 2023. "Carbon assets and Bitcoin: Hedging roles in global stock markets during the tranquil and turbulent periods?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(9), pages 1183-1203, September.
    5. Adekoya, Oluwasegun B. & Oliyide, Johnson A. & Noman, Ambreen, 2021. "The volatility connectedness of the EU carbon market with commodity and financial markets in time- and frequency-domain: The role of the U.S. economic policy uncertainty," Resources Policy, Elsevier, vol. 74(C).
    6. Demiralay, Sercan & Gencer, Hatice Gaye & Bayraci, Selcuk, 2022. "Carbon credit futures as an emerging asset: Hedging, diversification and downside risks," Energy Economics, Elsevier, vol. 113(C).
    7. Wen, Fenghua & Zhao, Lili & He, Shaoyi & Yang, Guozheng, 2020. "Asymmetric relationship between carbon emission trading market and stock market: Evidences from China," Energy Economics, Elsevier, vol. 91(C).
    8. Palao, Fernando & Pardo, Ángel, 2021. "The inconvenience yield of carbon futures," Energy Economics, Elsevier, vol. 101(C).
    9. Jin, Jiayu & Han, Liyan & Wu, Lei & Zeng, Hongchao, 2020. "The hedging effect of green bonds on carbon market risk," International Review of Financial Analysis, Elsevier, vol. 71(C).
    10. Xu, Xinkuo & Guan, Chengmei & Jin, Jiayu, 2018. "Valuing the carbon assets of distributed photovoltaic generation in China," Energy Policy, Elsevier, vol. 121(C), pages 374-382.
    11. Chen, Zhang-HangJian & Ren, Fei & Yang, Ming-Yuan & Lu, Feng-Zhi & Li, Sai-Ping, 2023. "Dynamic lead–lag relationship between Chinese carbon emission trading and stock markets under exogenous shocks," International Review of Economics & Finance, Elsevier, vol. 85(C), pages 295-305.
    12. Jianfeng Guo & Bin Su & Guang Yang & Lianyong Feng & Yinpeng Liu & Fu Gu, 2018. "How Do Verified Emissions Announcements Affect the Comoves between Trading Behaviors and Carbon Prices? Evidence from EU ETS," Sustainability, MDPI, vol. 10(9), pages 1-17, September.
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