Sustainability and stability: Will ESG investment reduce the return and volatility spillover effects across the Chinese financial market?

Abstract

This study provides a preliminary investigation of the relationship between sustainability and stability by investigating the impact of ESG investment on the return and volatility spillover effects in the major Chinese financial markets, including the stock, bond, interbank, and foreign exchange markets. We adopted both the TVP-VAR and DY methods to calculate the time-varying total, directional, and pairwise spillover indices. We examined the impact of ESG investment on financial market stability by comparing the spillover effects when ESG investment, represented by the ESG stock index, is considered with those without special consideration on the ESG investment, represented by the general stock index. The results show that when the ESG stock index replaces the general stock index, the total, directional, and pairwise spillover effects in the Chinese financial market generally decrease. Meanwhile, we find that although the overall Chinese financial market spillover index is around 13%, it is occasionally quite volatile. In particular, the markets were hugely uncertain in 2013 and 2020 due to the disequilibrium of supply and demand conditions in the money market and the considerable shocks created by the COVID-19 pandemic. We support the idea that, while the Chinese government develops its green finance, for instance, by advocating for ESG investment, it simultaneously builds a more stabilized financial market. In other words, sustainability and stability are positively correlated and can be achieved together. The reason for this is that ESG investment supports a long-run investment strategy by reducing excessive short-run speculation activities in the Chinese stock market, which accounts for the volatile property of the market since it was launched.