Climate Change and Long-Horizon Portfolio Choice: Combining Insights from Theory and Empirics

65 Pages Posted: 13 Sep 2021 Last revised: 11 Aug 2022

See all articles by Mathijs Cosemans

Mathijs Cosemans

Erasmus University - Rotterdam School of Management

Xander Hut

Erasmus University Rotterdam (EUR)

Mathijs A. van Dijk

Erasmus University Rotterdam (EUR)

Date Written: August 10, 2022

Abstract

We propose a novel approach to incorporating climate risk in long-horizon portfolio choice. Our method combines information from historical data about the impact of climate change on return dynamics with prior beliefs elicited from a temperature long-run risks (LRR-T) model. Investors with LRR-T beliefs perceive stocks to be much riskier over longer horizons because climate change weakens their beliefs in mean reversion and increases estimation risk and uncertainty about future expected returns. Because the perceived increase in long-horizon risk is not fully offset by higher equity premiums, the optimal allocation of buy-and-hold investors to equities decreases sharply with the horizon.

Keywords: climate change, long-run risks, prior beliefs, optimal portfolio choice, uncertainty

JEL Classification: C11, G11, G12, G23

Suggested Citation

Cosemans, Mathijs and Hut, Xander and van Dijk, Mathijs A., Climate Change and Long-Horizon Portfolio Choice: Combining Insights from Theory and Empirics (August 10, 2022). Available at SSRN: https://ssrn.com/abstract=3920481 or http://dx.doi.org/10.2139/ssrn.3920481

Mathijs Cosemans

Erasmus University - Rotterdam School of Management ( email )

Burgemeester Oudlaan 50
Rotterdam
Netherlands
+31104082371 (Phone)
+31104089017 (Fax)

HOME PAGE: http://www.mathijscosemans.com

Xander Hut (Contact Author)

Erasmus University Rotterdam (EUR) ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

Mathijs A. Van Dijk

Erasmus University Rotterdam (EUR) ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands

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