Hedging Climate Change News

TLDR

The study proposes a dynamic hedging procedure for climate change risk. The authors extract climate‑news innovations from newspaper text, model firm exposures with ESG scores, and construct mimicking‑portfolio hedge portfolios. The approach produces parsimonious, industry‑balanced portfolios that effectively hedge climate‑news innovations in‑sample and out‑of‑sample. Future research directions on financial climate‑risk management are discussed.

Abstract

Abstract We propose and implement a procedure to dynamically hedge climate change risk. We extract innovations from climate news series that we construct through textual analysis of newspapers. We then use a mimicking portfolio approach to build climate change hedge portfolios. We discipline the exercise by using third-party ESG scores of firms to model their climate risk exposures. We show that this approach yields parsimonious and industry-balanced portfolios that perform well in hedging innovations in climate news both in sample and out of sample. We discuss multiple directions for future research on financial approaches to managing climate risk.