Does carbon market add investment value in multi-asset portfolios? Evidence from hedge, safe haven, and portfolio performance

Abstract

This study explores the investment value of China's carbon market by analyzing its diversification potential and contribution. Specifically, we first assess the diversification potential from perspectives including potential identification, diversification roles, improvement on efficient frontier, and optimal weight analyses using the DCC-GARCH and dummy variable regression models. We further explore the diversification contribution by comparing the portfolio performance with and without the carbon market under various asset allocation strategies. Our results confirm the diversification potential of the carbon market and demonstrate its roles as both a hedge and a safe haven during the past decade and several periods of extreme market downturns. We also show the significant role of the carbon market in reducing portfolio risks. However, its risk-reducing capacity is weaker than that of green bonds, despite its superior return-enhancing capabilities in certain cases. Attractively, the diversification contribution of the carbon market is more pronounced in both portfolio risk reduction and return enhancement during turbulent periods compared to tranquil ones. These findings are crucial for developing effective asset allocation and risk management strategies.