From forests to faucets to fuel: Investigating the domino effect of extreme risk in timber, water, and energy markets
Introduction
Given the more frequent occurrence of various crises such as GFC, sovereign debt, pandemic, and War more recently, investors are constantly worried about the erosion of their wealth through downside risks in financial markets (Iqbal et al., 2022, 2022; Rao et al., 2022). In this regard, the COVID-19 pandemic put traditional energy (oil and gasoline) in the spotlight when crude oil recorded negative prices.1 The number of studies exploring safe-havens and hedges for energy markets has skyrocketed since then. Nonetheless, such studies investigate safe-haven properties of assets like gold (Madani and Ftiti, 2022), Bitcoin (Syuhada et al., 2022), and green bonds for traditional energy markets (Arif et al., 2022), substantially ignoring the role of natural investments, i.e., water and timber in this regard.
Although most of the inquiries on safe-havens for oil consider gold a most promising option (Kinateder et al., 2021; Syuhada et al., 2022), contrasting results are also available. For example, Ming et al. (2023) find that stable currencies, like the US Dollar and Swiss Franc, can serve as a better safe-haven for oil than gold. Similarly, Huang et al. (2022) conclude that green bonds perform better as a safe-haven for crude oil compared with gold. While examining the time-varying tail-risk dynamics between clean energy and oil sectors, Foglia et al. (2022) find that the two types of markets are distinct, hence, valuable investments in the same portfolio. Ahmed et al. (2022) find that gold communicates the least amount of tail-risk with the crude oil market compared with other precious metals, but this property weakens during COVID-19. Srivastava et al. (2023) show that the prediction of volatility and integration in natural resource markets, including gold and oil, can be improved through mixed modeling. However, it is interesting that neither tail-risk spillovers nor the safe-haven properties of water and timber assets are investigated for the crude oil market in the context of COVID-19 and beyond.
One of the reasons for water and timber not to be in the spotlight might stem from the scarce availability of funds/stocks in these sectors or the very nature of their businesses.2 However, this situation is expected to change due to the launch of ETFs and funds in this regard.3 Additionally, water and timber are not very trendy/catchy investments, like gold, oil, and Bitcoin, which provide enormous opportunities for short-term traders. As an essential-for-life commodity, water may be used to reduce portfolio risk through a defensive strategy; however, the likely water-scarcity soon provides a case for an aggressive investment strategy.4 On the other hand, timber investments can help in carbon sequestration and provide stable and safe returns.5 The demand for both timber forests and cut wood is bound to grow, raising value through carbon credits and wood sales in the wake of current efforts on climate change mitigation globally. Forests and timber are natural wood sources, covering colossal land areas, representing an indispensable metric for decreasing carbon emissions and producing oxygen. These existential and sustainable features of water and timber provide enormous opportunities for investments. As traditional energy markets contribute to carbon emissions, water and timber can provide an excellent offset against regulatory and litigation risks involved with investments in the oil and gas sector.
In the context that water sustainability is still a blind spot for investors to consider in their portfolios (Hogeboom et al., 2018), it is still unclear what motivates investments in this sector – social responsibility and/or financial benefits. Piñeiro-Chousa et al. (2020) suggest that investors’ attention affects water-related stocks negatively, supporting the later argument. The recent efforts in the formulation of global standards for sustainability reporting and sustainability materiality by GRI and IFRS6 are also contributing in terms of investors- and stakeholders- awareness, facilitating the amplified flow of investments in the ESG sector (Grewal et al., 2021; Pizzi et al., 2022; Karim et al., 2022).
Water, energy, and agriculture are essential to human life existence. The three sectors have intertwined/complex relationships, and output from one is often the input from others. Despite essential connections between these sectors, researchers have ignored the idea of water and/or timber performing safe-haven for energy markets. The dynamics of tail-risk spillovers in these markets are largely unexplored in this regard. How do water and timber assets communicate with oil and gas funds in extreme market downturns? Does this communication change (transmitter to receiver, high to low spillovers, and vice versa) during COVID-19? Can water and timber act as safe-havens for oil and gas markets? These are the questions we intend to answer in our analysis.
We contribute to the literature on safe-haven investments in three ways. First, we explore the role of less-researched natural investments, i.e., water and timber, for traditional energy assets. Second, we separately consider the COVID-19 period that proved disastrous for the crude oil market to check if the connectedness pattern changes during this pandemic. Third, we combine the conditional asymmetric-slope value-at-risk (CAViaR) approach with the TVP-VAR model to study tail-risk spillovers at 2.5%, 5%, and 10% VaR measures, providing robust estimates. Our study is close to Samitas et al. (2022), who study spillovers between natural alternative investments and other assets. However, our approach is different as we specifically focus on tail-risk spillovers and traditional energy markets in this regard. For our analyses, we benefit from daily values on two timber ETFs, two water funds, and three conventional energy funds in the United States.
Section snippets
Methodology and data
Our analysis considers an asset a safe-haven for underlying securities if not associated with them in market downturns Baur and Lucey, 2010, Karim et al., 2023a, Pham et al., 2022, Siddique et al., 2023). So, we consider risk spillovers between water, timber, and energy markets only in the lower tails of their VaR distributions. We combined two methodologies to assess tail risk spillovers of timber, water, and energy markets. Primarily, the conditional autoregressive value-at-risk (CAViaR)
Empirical results
Fig. 1 shows that the maximum value of 5% VaR (value-at-risk for 5% quantile) for all indices based on the Asymmetric-slope CaViaR model remains below 8% (averaging between 2 and 4%) before jumping to 20% (except for UNG) at the start of COVID19. Although average VaR values for UNG remained relatively higher throughout the sample period, it didn't jump with other variables at the onset of COVID-19. This shows that gas is immune to pandemic shock due to its major use in the household sector.
Conclusion
Using daily data from January 2010 to May 2022 on two water, two timber, and three energy (oil, gas, and gasoline) indices, we apply a combination of CAViaR and TVP-VAR approaches to study tail-risk spillovers. Water and timber are weakly connected to energy markets at 2.5%, 5%, and 10% VaR measures, showing the safe-haven attributes. Although the individual Value-at-Risk measures for all assets spike at the onset of COVID-19, tail-risk spillovers remain low during pre- and post-pandemic
CRediT authorship contribution statement
Muhammad Abubakr Naeem: Conceptualization, Data curation, Formal analysis, Investigation, Methodology, Project administration, Software, Supervision, Validation. Najaf Iqbal: Writing – original draft, Writing – review & editing, Conceptualization, Project administration, Validation, Visualization. Sitara Karim: Investigation, Methodology, Project administration, Writing – review & editing. Brian M. Lucey: Supervision.
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