Time-Varying Distributions and Dynamic Hedging with Foreign Currency Futures

Do Sustainable Stocks Offer Diversification Benefits for Conventional Portfolios? An Empirical Analysis of Risk Spillovers and Dynamic Correlations

“…In each panel, the row labeled 'undiversified' provides the summary statistics for an undiversified investor who is currently fully invested in the corresponding conventional market. As expected, the risk-minimizing portfolio strategy of [70] yields the largest reduction in return volatility, consistently in all panels. For example, focusing on Panel A, while the undiversified portfolio that is fully invested in the conventional world index has return volatility of 1.154%, supplementing the portfolio with the sustainable counterpart helps reduce portfolio risk down to 0.295% (0.293%), leading to a 93.5% (93.4%) reduction in portfolio volatility based on the MS-DCC (DCC) specification, respectively.…”

“…For example, focusing on Panel A, while the undiversified portfolio that is fully invested in the conventional world index has return volatility of 1.154%, supplementing the portfolio with the sustainable counterpart helps reduce portfolio risk down to 0.295% (0.293%), leading to a 93.5% (93.4%) reduction in portfolio volatility based on the MS-DCC (DCC) specification, respectively. Clearly the high conditional correlations between the conventional and sustainable stock indices reported earlier help reduce return volatility in the hedged portfolio as the strategy by [70] takes a short position in the corresponding sustainable index. On the other hand, the optimal portfolio weight strategy of [71] does not work as effectively in mitigating portfolio risk, yielding about 33% risk reduction at best in the case of the world index in Panel A.…”

“…For this purpose, we consider a currently 'undiversified' investor, i.e., an investor who is fully invested in a conventional stock index, and form bivariate portfolios by supplementing the undiversified portfolios with sustainable counterparts one at a time. Two alternative bivariate portfolios are examined, one based on the risk-minimizing portfolio strategy of [70]. (This model follows the dynamic risk-minimizing hedge ratio of [70] computed as θ * t = −h 12,t /h 2,t where h i,t = var(R i,t ) and h 12,t = cov(R 1,t , R 2,t ) with the subscripts 1 and 2 representing the assets in the bivariate portfolio.…”

“…Two alternative bivariate portfolios are examined, one based on the risk-minimizing portfolio strategy of [70]. (This model follows the dynamic risk-minimizing hedge ratio of [70] computed as θ * t = −h 12,t /h 2,t where h i,t = var(R i,t ) and h 12,t = cov(R 1,t , R 2,t ) with the subscripts 1 and 2 representing the assets in the bivariate portfolio. In our application, this is based on a $1 long position in the conventional portfolio.)…”

“…Table 5 presents the summary statistics for the in-sample period covering 2 January 2004-19 February 2014, with 2644 observations. We report in the table the summary statistics for portfolio returns as well as the optimal portfolio weights based on the portfolio strategies of [70,71]. Hedge effectiveness (HE), measured as the percentage of portfolio return volatility that is reduced by supplementing the undiversified portfolio with the sustainable index, along with the corresponding Sharpe ratios, are also reported in the table.…”