Quantile connectedness of oil price shocks with socially responsible investments

We use a new method to disentangle various sources of oil price shocks and find how these sources are connected to major global environmental, social, and governance (ESG) equity indices under extreme market movements using daily data from October 2007 to March 2022. Our quantile-based connectedness analysis shows that return connectedness considerably amplifies with the size of the shock for both positive and negative shocks, indicating that oil shocks spread more intensely during extreme market movements. We also find that oil shocks originating from unexpected variation in demand and risk substantially contribute to the variation in the ESG returns while supply shocks have relatively little effect when estimated at the median level but the contribution of all different types of shocks remain extremely high when analyzed at the tails. Our results indicate that socially responsible investments are prone to contagion and thus offer limited portfolio diversification benefits under extreme market movements. One clear implication of our study is that investors need to carefully design their risk management and diversification strategies to account for not only the source of the oil shocks but also the magnitude of the oil shock on their green equity investments. We also show that total dynamic connectedness significantly increased during the global financial crisis, European debt crisis, the Brexit episode and the recent COVID-19 outbreak.