Benchmark-Adjusted Volatility Regimes in Selected Sustainable ETFs: Evidence from Broad ESG and Paris-Aligned Funds in the U.S. and Europe

This study examines the benchmark-relative volatility dynamics in four selected sustainable exchange-traded funds (ETFs) representing broad environmental, social, and governance (ESG) and Paris-aligned products in the U.S. and European markets. This study contributes to the literature by examining how the volatility and cross-market synchronization of relative performance change over time, rather than focusing on raw returns or average performance. Using daily data from January 2019 to April 2026, we estimate two-regime Markov-switching models for benchmark-adjusted returns. The models allow for structural breaks, and account for energy returns, sovereign yields, and implied volatility. At the daily frequency, our model estimates reveal normal and stress regimes in all four ETF return series, with a substantially higher variance in the stress regime. Regime separation is clearer for the two Paris-aligned funds, and the European funds generally experience shorter stress regimes. The difference in regime separation between the Paris-aligned and broad ESG funds remains across most robustness checks. However, individual estimates of stress frequency and episode timing are less stable, particularly for the broad ESG funds under alternative benchmarks. Cross-market synchronization of stress regimes is limited for both product pairs. Overall, the findings show that sustainability labels do not imply uniform benchmark-relative risk dynamics across products and regions, with potential implications for portfolio diversification and sustainable investment product design.