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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, L
Simm, I
Item Type: Journal Article
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: 1-Apr-2021
Date of Acceptance: 7-Oct-2019
URI: http://hdl.handle.net/10044/1/73840
DOI: 10.1007/s10479-019-03458-x
ISSN: 0254-5330
Publisher: Springer
Start Page: 847
End Page: 871
Journal / Book Title: Annals of Operations Research
Volume: 299
Issue: 1-2
Copyright Statement: © The Author(s) 2019. This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license, and indicate if changes were made.
Keywords: Science & Technology
Operations Research & Management Science
Climate change
Carbon pricing
Bayesian analysis
Black-Litterman model
Portfolio theory
Operations Research
01 Mathematical Sciences
08 Information and Computing Sciences
15 Commerce, Management, Tourism and Services
Publication Status: Published
Online Publication Date: 2019-11-27
Appears in Collections:Imperial College Business School

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