Hedging Climate Risk

50 Pages Posted: 24 Sep 2014 Last revised: 12 Apr 2016

See all articles by Mats Andersson

Mats Andersson

AP4

Patrick Bolton

Imperial College London; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Frédéric Samama

Sciences Po, S&P

Date Written: September 7, 2015

Abstract

This paper presents a simple dynamic investment strategy that allows long-term passive investors to hedge climate risk without sacrificing financial returns. We illustrate how tracking error can be almost eliminated even for a low carbon index that has 50% less carbon footprint than its benchmark. By investing in such a decarbonized index, investors are holding in effect a “free option on carbon”: as long as the introduction of significant limits on CO2 emissions is postponed our low carbon index obtains the same return as the benchmark index, but when CO2 emissions are integrated by the market, it starts outperforming the benchmark.

Keywords: Climate Risk, Green Index, Tracking Error, Free Option on Carbon

JEL Classification: G11

Suggested Citation

Andersson, Mats and Bolton, Patrick and Samama, Frederic, Hedging Climate Risk (September 7, 2015). Financial Analysts Journal, vol. 72, no. 3 (May/June 2016 Forthcoming) , Available at SSRN: https://ssrn.com/abstract=2499628 or http://dx.doi.org/10.2139/ssrn.2499628

Mats Andersson

AP4 ( email )

PO Box 3069
Regeringsgatan 30-32
Stockholm, SE 103 61
Sweden
46 8 787 75 51 (Phone)

Patrick Bolton (Contact Author)

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Frederic Samama

Sciences Po, S&P ( email )

40 Rue de Courcelles
Paris, 75017
France

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