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

66 Pages Posted: 13 Sep 2021

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: July 29, 2021

Abstract

We propose a novel approach for measuring the impact of climate change on long-horizon equity risk and optimal portfolio choice. Our method combines historical data about the impact of climate change on return dynamics with prior beliefs elicited from the temperature long-run risk (LRR-T) model of Bansal, Kiku, and Ochoa (2019). Our Bayesian framework incorporates this prior information to obtain more precise estimates of long-term climate risks than existing methods that solely rely on historical data. Compared to the benchmark investor without climate change, we document that the LRR-T Bayesian investor predicts higher equity premia for all investment horizons, with per period variance increasing considerably over the horizon. This results in relatively (high) low allocations to equities in the (short) long run. Investors that optimize between portfolios that are vulnerable and non-vulnerable to climate change only diversify in the long run.

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

JEL Classification: C11, G11, G12

Suggested Citation

Cosemans, Mathijs and Hut, Xander and Van Dijk, Mathijs A., Climate Change and Long-Horizon Portfolio Choice: Combining Theory and Empirics (July 29, 2021). 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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