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Climate change investment risk: optimal portfolio construction ahead of the transition to a lower-carbon economy

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Title: Climate change investment risk: optimal portfolio construction ahead of the transition to a lower-carbon economy
Authors: Benedetti, D
Biffis, E
Chatzimichalakis, F
Lilloy Fedele, LR
Simm, I
Item Type: Working Paper
Abstract: There is an increasing likelihood that governments of major economies will act within the next decade to reduce greenhouse gas emissions, probably by intervening in the fossil fuel markets through taxation or cap & trade mechanisms (collectively “carbon pricing”). We develop a model to capture the potential impact of carbon pricing on fossil fuel stocks, and use it to inform Bayesian portfolio construction methodologies, which are then used to create what we call Smart Carbon Portfolios. We find that investors could reduce ex-post risk by lowering the weightings of some fossil fuel stocks with corresponding higher weightings in lower-risk fossil fuel stocks and/or in the stocks of companies active in energy efficiency markets. The financial costs of such de-risking strategy are found to be statistically negligible in risk-return space. Robustness of the results is explored with alternative approaches.
Issue Date: 6-Jun-2020
URI: http://hdl.handle.net/10044/1/72001
DOI: https://dx.doi.org/10.2139/ssrn.3281390
Copyright Statement: ©2019 The Author(s).
Keywords: Climate Change
Carbon Pricing
Bayesian Analysis
Black-Litterman Model
Portfolio Theory
Climate Change
Carbon Pricing
Bayesian Analysis
Black-Litterman Model
Portfolio Theory
Publication Status: Published
Open Access location: http://dx.doi.org/10.2139/ssrn.3281390
Appears in Collections:Imperial College Business School