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The Impact of Climate Change Risk on Long-Term Asset Allocation

Author

Listed:
  • Jean-Charles Bertrand

    (HEC Paris - Ecole des Hautes Etudes Commerciales)

  • Guillaume Coqueret

    (EM - EMLyon Business School)

  • Nicholas Mcloughlin
  • Stéphane Mesnard

Abstract

The authors propose a framework for long-term cross-asset portfolio choice in which the estimation of the covariance matrix is subject to climate risk. They model the future volatility and correlation of assets as a linear function of three types of forward-looking variables: the long-term future average, climate-aware projections of economic indicators, and scenarios for the temperature anomaly. They analyze the shifts from a baseline 60/40 equity/bond allocation when taking climate risk into account. The takeaways are the following: 1) these changes are small and mostly favorable to bonds if the focus is on the estimation of risk components; 2) including climate-driven expected returns in the optimization substantially alters the compositions but to the benefit of equities; 3) in all cases, the risk-adjusted returns decrease, often significantly, when taking climate impact into account.

Suggested Citation

  • Jean-Charles Bertrand & Guillaume Coqueret & Nicholas Mcloughlin & Stéphane Mesnard, 2024. "The Impact of Climate Change Risk on Long-Term Asset Allocation," Post-Print hal-04430743, HAL.
    • Handle: RePEc:hal:journl:hal-04430743
    DOI: 10.3905/jpm.2024.1.586
    as

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