Portfolio selection from risk transfer mechanisms in a time of crisis for renewable energy markets

Abstract

This study investigates risk transmission in financial markets, focusing on investor’s hedging decisions and how risk moves between renewable and fossil fuel energy assets within energy ETFs during the Global Financial Crisis (GFC) and the COVID-19 pandemic. A novel approach is introduced to assess how the volatility of a single energy asset affects the risk of an entire energy portfolio, providing valuable insights for policymakers, investors, and energy producers in managing financial risk. The analysis focuses on three major renewable energy ETFs (solar, wind, and hydro) and three major fossil fuel energy ETFs (oil, coal, and natural gas). During the COVID-19 crisis, asset combinations like (solar, coal), and (wind, coal), were found to effectively minimize losses. Although not ideal for solar-related risks, the (solar, oil) combination proved advantageous, particularly oil-related shocks. The study also finds that combining solar with oil and wind with oil was effective in mitigating losses during the GFC and before the COVID-19 pandemic. In non-crisis periods, asset combinations such as (solar, oil) or (solar, coal) offer robust risk management strategies. This research highlights the interconnectedness of energy assets and the importance of using crisis-specific forecasting models, which significantly improve forecasting accuracy. Further research could explore similar impacts from events like the Russia-Ukraine war, which could affect energy markets.