Assessing the driving forces of clean and traditional energy exchange-traded funds returns and their time-varying correlation

The greatest danger to human life seems to be represented by the increase in temperatures, mainly provoked by the production of energy from burning fossil fuels. To preserve human life on Earth, it is necessary to switch as fast as possible to green technologies for producing energy. The present research tackles this switch from a financial point of view. Exchange-traded funds (ETFs) are becoming the most important way of private financing of investments. This study examines the financial performance of clean energy companies compared to traditional oil and gas companies, measured in terms of ETF returns. Specifically, it first assesses the drivers of the two types of energy ETF returns and then compares and explains their dynamic correlation over time. The empirical analysis includes a large set of both conventional and novel explanatory variables - macro-commodity variables, financial variables, climate determinants, psychological factors and special event variables. The results, based on a set of Generalised AutoRegressive Conditional Heteroskedasticity (GARCH) and Dynamic Conditional Correlation (DCC) models, reveal that a mix of factors affect ETF returns and their correlation. Both energy ETFs are extremely sensitive to the US Dollar exchange rate, crude oil, inflation expectations and financial market conditions. The rising trend in clean energy companies has been pushed by increasing climate awareness and the Greta Thunberg's effect. The lockdown has negatively affected traditional energy ETFs, but the Russia-Ukraine war has impacted only clean ETFs. The findings imply that, notwithstanding the growth of the renewable energy market and the success of clean companies, the path toward decarbonisation is still long and complex. However, sound investments in the global energy sector could favour a virtuous transition toward renewables.