Measuring and Managing Carbon Risk in Investment Portfolios

58 Pages Posted: 22 Sep 2020

See all articles by Théo Roncalli

Théo Roncalli

University of Paris-Saclay

Théo Le Guenedal

CREST - ENSAE

Frederic Lepetit

Amundi Asset Management

Thierry Roncalli

Amundi Asset Management; University of Evry

Takaya Sekine

Amundi Asset Management

Date Written: August 26, 2020

Abstract

This article studies the impact of carbon risk on stock pricing. To address this, we consider the seminal approach of Görgen et al. (2019), who proposed estimating the carbon financial risk of equities by their carbon beta. To achieve this, the primary task is to develop a brown-minus-green (or BMG) risk factor, similar to Fama and French (1992). Secondly, we must estimate the carbon beta using a multi-factor model. While Görgen et al. (2019) considered that the carbon beta is constant, we propose a time-varying estimation model to assess the dynamics of the carbon risk. Moreover, we test several specifications of the BMG factor to understand which climate change-related dimensions are priced in by the stock market. In the second part of the article, we focus on the carbon risk management of investment portfolios. First, we analyze how carbon risk impacts the construction of a minimum variance portfolio. As the goal of this portfolio is to reduce unrewarded financial risks of an investment, incorporating the carbon risk into this approach fulfills this objective. Second, we propose a new framework for building enhanced index portfolios with a lower exposure to carbon risk than capitalization-weighted stock indices. Finally, we explore how carbon sensitivities can improve the robustness of factor investing portfolios.

Keywords: Carbon, climate change, risk factor, Kalman filter, minimum variance portfolio, enhanced index portfolio, factor investing

JEL Classification: C61, G11

Suggested Citation

Roncalli, Théo and Le Guenedal, Théo and Lepetit, Frederic and Roncalli, Thierry and Sekine, Takaya, Measuring and Managing Carbon Risk in Investment Portfolios (August 26, 2020). Available at SSRN: https://ssrn.com/abstract=3681266 or http://dx.doi.org/10.2139/ssrn.3681266

Théo Roncalli

University of Paris-Saclay ( email )

Avenue de la Terrasse
Gif Sur Yvette, 91198
France

Théo Le Guenedal

CREST - ENSAE ( email )

France

Frederic Lepetit

Amundi Asset Management ( email )

90 Boulevard Pasteur
Paris, 75015
France

Thierry Roncalli (Contact Author)

Amundi Asset Management ( email )

90 Boulevard Pasteur
Paris, 75015
France

University of Evry ( email )

Boulevard Francois Mitterrand
F-91025 Evry Cedex
France

Takaya Sekine

Amundi Asset Management ( email )

90 Boulevard Pasteur
Paris, 75015
France

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