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

A firm’s negative environmental performance directly affects its financial outcomes, such as returns and stock price volatility. Consequently, the role of investors’ attitudes toward environmentally responsible investment in shaping growth dynamics has recently occupied center stage in research and policy debates. This paper quantifies the financial relevance of environmental, social, and governance (ESG) assets by rigorously assessing the dynamic interactions of returns and volatility between the global financial stress index and various ESG-themed assets. We study how periods of financial turbulence impact performance and resilience narratives of these investments. Given the inherently dynamic nature of these interactions, we identify distinct spillover effects by estimating a Time-varying Parameter Vector Autoregression model using a high-frequency, decade-long sample (February 28, 2014 to March 06, 2024), which covers multiple crisis periods including the COVID-19 pandemic and the ongoing Russia-Ukraine and Israel-Gaza wars. Our findings reveal that volatility connectedness peaked during the COVID-19 pandemic and was weakest during the Israel-Gaza war. While short-term developments dominate return connectedness, volatility connectedness is 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. Across ESG markets and at both frequencies, the global ESG index emerged as the primary source of return and volatility connectedness, whereas the Asia-Pacific ESG market was the main recipient 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.