Sustainable portfolio management under climate change

Abstract

This paper discusses the management of climate change risks for equity investments and presents a scenario-based framework for building sustainable portfolios under the climate change scheme. An empirical analysis is first performed using historical price data to show the inferior risk-adjusted performance of the carbon-intensive industries in the North American stock market, which supplements evidence from existing literature in the market's gradual pricing of the climate change risk. Risk management modules are devised with subjective top-level constraints to achieve comprehensive coverage of the key aspects of climate change: risk exposures are measured by carbon intensities, while the risk impacts are quantified through equity return impact scenarios derived from climate change paths under Integrated Assessment Models. A model for quantifying stranded asset risk is also presented. Results from these modules formulate the joint posterior return distribution of the stocks that are used to construct the mean-variance optimal portfolio.