The dynamic connectedness between collateralized loan obligations and major asset classes.

What is it about?

• We investigate the dynamic connectedness between collateralized loan obligations (CLOs) and diverse financial assets. • We also analyze the hedging ability of CLOs, for the whole sample period and various sub-periods, by utilizing conditional variance estimations (DCC-GARCH). • Moderate volatility spillovers are documented, which escalated during the collapse in oil prices, the US-China trade war, the COVID-19 pandemic and the surging inflation. • CLOs are proven to be an efficient hedging tool for all the sampled assets regardless of the period studied.

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Why is it important?

Motivated by the increasing demand for alternative assets that can contribute to reducing portfolio risk, this paper examines the volatility spillovers between collateralized loan obligations (CLOs) and various in-demand investment instruments, including equities, bonds, crude oil, commodities, gold, bitcoin, shipping and real estate. The applied methodology comprehends the time-varying parameter vector autoregressive (TVP-VAR) modification of the classical spillover approach, for the period from January 1, 2012 to August 31, 2023. The empirical findings show moderate levels of dynamic connectedness; albeit several external shocks strengthened the interconnection among the assets. Moreover, we compare the ability of CLOs for hedging, during the overall sample period and multiple sub-periods, by estimating hedge ratios and optimal portfolio weights, in order to inform investors about feasible portfolio adjustments. Our results indicate that CLOs constitute an effective hedging tool, irrespective of the period covered, as the short position in their volatility provides high hedging effectiveness for investors holding long-positions in the volatility of all the remaining assets.

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