Water exchange traded funds: A study on idiosyncratic risk using Markov switching analysis

Abstract

We investigate the relationship between idiosyncratic risk and return among four water exchange traded funds—PowerShares Water Resources Portfolio, Power Shares Global Water, First Trust ISE Water Index Fund, and Guggenheim S&P Global Water Index ETF using the Markov switching model for the period 2007–2015. The generated transition probabilities in this paper show that there is a high and low probability of switching between Regimes 1 and 3, respectively. Moreover, we find that the idiosyncratic risk for most of the exchange traded funds move from low volatility (Regime 2) to very low volatility (Regime 1 and 3). Our study also identify that the beta coefficients are positive and entire values are less than 1. Thus, it seems that water investment has a lower systematic risk and a positive effect on the water exchange traded index funds returns during different regimes.

Keywords:

• idiosyncratic risk
• water investment
• transition probabilities
• Markov switching model
• water exchange traded funds

Public Interest Statement

Water is essential for life and has been studied to some extent but not as much in terms of major investments and their associated risks. The issues related to climate change has increased the risk of even more people in the world living with lack of adequate water for drinking. To remove this crisis, water investments in a number of areas are urgently needed. This study provides impetus for further study of the financial aspects of the water industry and its related risks. In particular, this paper contributes by increasing the investor’s understanding of the idiosyncratic risk of water investments. The results and findings will guide investors’ in decision-making.

Additional information

Funding

Funding. The authors received no direct funding for this research.

Notes on contributors

Gurudeo Anand Tularam

Gurudeo Anand Tularam is a senior lecturer in Mathematics/Statistics in the Griffith Sciences-Science, Environment, Engineering and Technology, and a senior researcher at the Environmental Futures Institute, Griffith University, Australia. His research expertise in time series and stochastic calculus methods in business and finance applications such as investment, portfolio analysis, and risk assessment. He has published more than hundred papers in reputed international journals.

Rajibur Reza

Rajibur Reza is a PhD candidate at the Department of Accounting, Finance and Economics, Griffith Business School, Griffith University, Australia.