Asymmetric multifractal behaviour and network connectedness between socially responsible stocks and international oil before and during COVID-19

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Abstract

Energy market is witnessed to have high integration with international equity markets ranging from traditional assets to newly introduced asset classes, especially after increased financialization during the last decade. We compare the connectedness between international oil market and socially responsible stocks before and during the recent pandemic COVID-19. Socially responsible stocks are increasingly becoming popular because of their social cause as well as less integration with other assets, however since their acceptance, have never been tested against the contagion phenomena. We utilize daily data ranging from March 2016 to June 2020 to investigate integration and spillover before and during COVID-19 period. Our methodological framework includes asymmetric multifractal detrended approach, network connectedness and conditional diversification measures. Our sampled SRI funds exhibit multifractal behaviour and share bidirectional spillover with oil. The SRI funds demonstrate good hedging abilities during normal and COVID-19 period and for similar reason are suggested as optimal asset together with oil futures in a portfolio. Furthermore, these SRI funds yield optimal diversification benefits with oil futures under bearish market conditions.

Introduction

Last decade has witnessed an increasing interest of the investment community in socially responsible investments (SRI) attributable to investors choice to apply social, environmental and governance lens to their investment. According to US sustainable, responsible and impact investing report [1], an increase of 38% is witnessed across 12 trillion dollars of professionally managed funds since 2016 with an average annual growth of 13.6% since 1995. In addition, 44% increase is observed in assets managed by money managers and community investing institutions, reflecting that recent investment trends have now shifted to consider more diverse set of social, environmental and governance factors for optimal returns while being socially responsible. Similarly, individual investors are also more interested to invest in socially responsible way aligning personal values and their financial objectives.

In the last decade, international oil prices have shown high degree of volatility. The first shock was observed after almost four years of stability in the oil market when the average price of crude oil dropped from the highest pricing level of $112 per barrel in April 2012 to $106 per barrel in June 2014, followed by a further decrease of 56% to $45 USD in January 2015. After a partial recovery to $64 per barrel, the prices declined again to their lowest level since 2003 to $28 per barrel, more than 50% drop in January 2016. To sum up, oil prices fell by approximately 72% since the beginning of the oil turbulence in 2014 which took almost four years since January 2015 (from the first lowest price of $45 per barrel) to reach up to $74 per barrel. However, this volatility in international oil prices continued as oil prices again dropped to $45 per barrel in December 2018. Most recently, the global wave of COVID-19 pandemic pushed oil market into another record floor price of approximately $12 in April 2020.1

The recent wave of COVID-19 pandemic led global equity markets into enormous risks. For instance, Ashraf [2] examine the impact of COVID-19 on the stock markets of 64 countries and find significant decline in returns. Zhang et al. [3] examine the relationship between COVID-19 pandemic and stock markets globally and conclude that equity markets have become more volatile and unpredictable due to the uncertainty caused by this pandemic. In addition, Sharif et al. [4] analyse the unprecedented impact of COVID-19 on Dow Jones 30 index and report causal effect of COVID-19 Dow Jones 30 index. Our motivation for this work comes from three different ideas. First is the presence of the extant literature on integration between oil and socially responsible stocks.2 Investment in socially responsible stocks is comparatively a new concept and limited research is done on identifying their potential to earn optimal returns in a portfolio together with oil futures. Second, the recent wave of COVID-19 pandemic has affected the economic and financial environment on global basis and though the effect on traditional asset classes is investigated, the sensitivity of socially responsible stocks is yet to be found. Furthermore, the concept of socially responsible investing became more popular among the investment community since last five years and since then no major financial crisis has struck on global basis. The situation of COVID-19 is a global phenomenon and significantly affected the international financial markets, and therefore motivates us to investigate the behaviour of SRI stocks before and after this pandemic. Third, the oil prices during this COVID-19 period has dropped significantly and beyond previously recorded levels, therefore the stock markets became vulnerable not only because of COVID-19 period but also experience downside risk from declining international oil prices. Fourth, given the unpredictable behaviour of financial markets to COVID-19 crisis period and recorded decline in oil prices, we investigate the asymmetric properties of oil and socially responsible stocks using asymmetric multifractal detrended fluctuation analysis (AMFDFA). To investigate the behaviour of socially responsible stocks and oil together in a portfolio, we apply different risk ratios followed by conditional diversification benefits (also referred as CDB) analysis. Finally, we use DY (2014) network connectedness approach to measure spillover between international oil returns and SRI stocks before and during COVID-19 situation.

Our contribution in this paper is based on measuring the integration between socially responsible stocks and oil returns. Oil prices have a volatile nature and also a great influence on the international economics and financial markets. Therefore, an investigation between the returns comovement of SRI stocks and oil returns can help investors in understanding their return dynamics in a single portfolio. It will also help investor in measuring the sensitivity of these socially responsible stocks to international oil market since there is ample evidence of stock market sensitivity to international oil prices [7]. We also test spillover effect between the SRI stocks and oil returns using network connectedness approach based on Diebold and Yilmaz [8] volatility spillover. This can highlight the net transmitter and receiver of volatility among a wider set of assets. To access the risk of combining each SRI stock with oil futures, we perform risk measures that compare the inherent risk for each individual portfolio of SRI with oil futures. Finally, we measure conditional diversification benefits under extreme and normal market conditions between each individual SRI and oil futures under different combination of asset’s weight. This application of conditional diversification benefits is also useful in measuring diversification benefits under extreme market conditions like the current COVID-19 period.

Our results highlight that SRI funds exhibit bidirectional spillover with oil returns however with low magnitude. Low carbon stocks appear as major recipient of spillover from other SRI funds consistently across the complete sampling period. These socially responsible stocks exhibit good hedging abilities for oil futures and act as safe haven during COVID-19 period. Finally, the SRI funds highlight diversification benefits together with oil futures under different probability levels for expected shortfall and we witness more diversification benefits under bearish market conditions. Remainder of our work is organized as follows. Section 2 reviews relevant literature. Section 3 explains the estimation techniques. Section 4 highlight data sources and preliminary analysis. Section 5 presents analysis of results following Section 6 which concluded our work.

Section snippets

Literature review

The impact of international oil prices on stock returns has ample evidence3 in existing literature (See [12], [13], [14], [15], [16]; [17], etc.). Crude oil not only has a substantial impact on traditional assets but on several other commodity markets (see [18], [19]), precious metals [20], [21], [22] and foreign currency market [23], [24], [25]. Oil prices are considered as an important factor for different aspects of any economy and its increasing

Asymmetric multifractal detrended fluctuation analysis

To apply asymmetric MF-DFA, we suppose a series of length N, X=xtt=1N for profile Y={yt}t=1N of {xt}, where yt=j=1txjx¯,j=1,2,3,,N and x¯ symbolizes​ the average of the series X. The second step is based on the recommendation of Peng et al. [79] for which the series X and its profile Y are divided into non-overlapping segments of similar length n, selected from 5 to N/4. Since, N is not necessarily a multiple of n, there could be a remaining short part at the end of the series. The same

Data

With respect to ESG as an investment strategy, an increasing interest of the investment community is witnessed in recent years. The ESG concept stands for environmental, social and governance measures which align investor’s objective to invest in the values of the companies. Our sample of socially responsible funds include Fossil Fuel Reserve Free ETF Index (Fossil Fuel), Social Choice Equity Funds (Social Choice Equity), USA ESG, Low Carbon Exchange Traded Funds (Low Carbon), Social Exchange

Conclusion

Our work examines the presence of returns integration between international oil market and socially responsible stocks from March 2016 to June 2020. Changes in international oil market are considered as an important factor on the returns of conventional stock markets. However, in the last couple of decades, different assets have emerged as important investment options among which, socially responsible stocks are becoming popular among the investment community. Existing literature is limited in

CRediT authorship contribution statement

Mobeen Ur Rehman: Conceptualization, Data curation, Formal analysis, Software, Supervision. Nasir Ahmad: Writing – original draft, Investigation. Xuan Vinh Vo: Conceptualization, Supervision, Investigation, Writing – review & editing.

Declaration of Competing Interest

The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.

Acknowledgement

This research is partly funded by the University of Economics Ho Chi Minh City, Vietnam .

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