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Hedging Climate Risk

Author

Listed:
  • Mats Andersson
  • Patrick Bolton
  • Frédéric Samama

Abstract

We present a simple dynamic investment strategy that allows long-term passive investors to hedge climate risk without sacrificing financial returns. We illustrate how the tracking error can be virtually eliminated even for a low-carbon index with 50% less carbon footprint than its benchmark. By investing in such a decarbonized index, investors in effect are holding a “free option on carbon.” As long as climate change mitigation actions are pending, the low-carbon index obtains the same return as the benchmark index; but once carbon dioxide emissions are priced, or expected to be priced, the low-carbon index should start to outperform the benchmark.Editor’s note: The views expressed in this article are those of the authors and do not necessarily reflect the views of the Amundi Group, AP4, or MSCI.Editor’s note: This article was reviewed and accepted by Executive Editor Stephen J. Brown and Executive Editor Robert Litterman.

Suggested Citation

  • Mats Andersson & Patrick Bolton & Frédéric Samama, 2016. "Hedging Climate Risk," Financial Analysts Journal, Taylor & Francis Journals, vol. 72(3), pages 13-32, May.
    • Handle: RePEc:taf:ufajxx:v:72:y:2016:i:3:p:13-32
    DOI: 10.2469/faj.v72.n3.4
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    Citations

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    Cited by:

    1. Stefano Ramelli & Alexander F. Wagner & Richard J. Zeckhauser & Alexandre Ziegler, 2018. "Investor Rewards to Climate Responsibility: Evidence from the 2016 Climate Policy Shock," NBER Working Papers 25310, National Bureau of Economic Research, Inc.
    2. Bolton, Patrick & Kacperczyk, Marcin, 2021. "Do investors care about carbon risk?," Journal of Financial Economics, Elsevier, vol. 142(2), pages 517-549.
    3. Benoît Mercereau & Guillaume Neveux & João Paulo C. C. Sertã & Benoît Marechal & Gianluca Tonolo, 2020. "Fighting climate change as a global equity investor," Journal of Asset Management, Palgrave Macmillan, vol. 21(1), pages 70-83, February.
    4. Inderst, Roman & Opp, Markus, 2022. "Socially optimal sustainability standards with non-consequentialist ("warm glow") investors," SAFE Working Paper Series 346, Leibniz Institute for Financial Research SAFE.
    5. Mathias S. Kruttli & Brigitte Roth Tran & Sumudu W. Watugala, 2019. "Pricing Poseidon: Extreme Weather Uncertainty and Firm Return Dynamics," Finance and Economics Discussion Series 2019-054, Board of Governors of the Federal Reserve System (U.S.).
    6. Patrick Bolton & Zachery Halem & Marcin Kacperczyk, 2022. "The Financial Cost of Carbon," Journal of Applied Corporate Finance, Morgan Stanley, vol. 34(2), pages 17-29, June.
    7. Bharat Kumar Meher & Abhishek Anand & Sunil Kumar & Ramona Birau & Manohar Sing, 2024. "Effectiveness of Random Forest Model in Predicting Stock Prices of Solar Energy Companies in India," International Journal of Energy Economics and Policy, Econjournals, vol. 14(2), pages 426-434, March.
    8. Kacperczyk, Marcin & Bolton, Patrick, 2020. "Carbon Premium around the World," CEPR Discussion Papers 14567, C.E.P.R. Discussion Papers.
    9. Chen, Zhuo & Liu, Jinyu & Lu, Andrea & Tao, Libin, 2024. "Carbon dioxide and asset pricing: Evidence from international stock markets," Journal of Empirical Finance, Elsevier, vol. 75(C).
    10. Po‐Hsuan Hsu & Kai Li & Chi‐Yang Tsou, 2023. "The Pollution Premium," Journal of Finance, American Finance Association, vol. 78(3), pages 1343-1392, June.

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