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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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