Systemic financial stress and the returns and volatility of ESG-themed assets

Negative environmental performance of a firm has a direct impact on its financial outcomes, such as returns and volatility of stock prices. Hence, how an investor’s aptitude towards environmentally responsible investment drives growth-dynamics, has occupied a center stage in research and policy dialogues recently. This paper quantifies financial relevance of environmental, social and governance assets by undertaking a rigorous assessment of interactions of the dynamic return and volatility between global financial stress index and various ESG-themed assets. We study how periods of financial turbulence impact performance and resilience narratives of these investments. Due to inherent dynamic nature of interaction, we identify distinct spillover effects by estimating a Time-varying Parameter Vector Autoregression method for a high-frequency decade-long sample (February 28, 2014 to March 06, 2024), covering different crises periods including the COVID-19 pandemic and the ongoing Russia-Ukraine and Israel-Gaza wars. Our findings reveal that volatility connectedness was strongest during the COVID-19 pandemic but was the weakest during the Israel-Gaza war. Whereas short-term developments dominate return connectedness among these variables, volatility connectedness is found to be consistently driven by long-term factors. In terms of return connectedness, financial stress is found to be a net transmitter of shocks to the ESG market in the short term, while in terms of volatility connectedness, it is also a net transmitter of shocks except during war periods. Among the ESG markets, for both frequencies, the global ESG index was the main source of both return and volatility connectivity, while the Asia-Pacific ESG market was the main destination of shocks. Our results can guide investors, policy makers, and companies in adopting and promoting specific ESG practices, ultimately fostering a more resilient and sustainable global economy.