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Hedging Climate Risk

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

Mats Andersson

AP4

Patrick Bolton

Columbia Business School - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Frédéric Samama

SWF Research Initiative, Amundi

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, Frédéric, 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)

Columbia Business School - Department of Economics ( email )

420 West 118th Street
New York, NY 10027
United States

HOME PAGE: http://www0.gsb.columbia.edu/faculty/pbolton/

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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

Frederic Samama

SWF Research Initiative, Amundi ( email )

91-93, boulevard Pasteur
Paris, 75015
France

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