Price of climate risk hedging under uncertainty

Abstract

In this manuscript, we examine the welfare benefits of climate risk hedges and the effects of climate uncertainty on optimal portfolios with different investment horizons. We consider the case when an investor who trades in a stock market also holds a claim that pays off when an adverse climate scenario materializes. The optimal investment strategy, the price of the claim, and the cost of climate change uncertainty are derived. It is shown that climate uncertainty reduces stock investment. Furthermore, an increase in climate uncertainty decreases investor’s welfare, even when climate risk hedging instruments are available.