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

2023 WFA Meetings Paper

71 Pages Posted: 13 Sep 2021 Last revised: 9 Jun 2023

See all articles by Mathijs Cosemans

Mathijs Cosemans

Erasmus University - Rotterdam School of Management

Xander Hut

Goethe University Frankfurt

Mathijs A. van Dijk

Erasmus University Rotterdam (EUR)

Date Written: May 31, 2023

Abstract

We study how investor beliefs about the economic impact of climate change affect long-horizon portfolio choice. We show that buy-and-hold investors who elicit prior views from a temperature long-run risks (LRR-T) model allocate less capital to equities at longer horizons. These investors perceive stocks to be riskier over longer holding periods because climate change weakens their beliefs in mean reversion and increases estimation risk and uncertainty about future expected returns. Climate risk also reduces the optimal allocation to equity for long-term investors with LRR-T beliefs who dynamically rebalance their portfolio, because it generates a negative intertemporal hedging demand.

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 (May 31, 2023). 2023 WFA Meetings Paper, 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)

Goethe University Frankfurt ( email )

Finance Department
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Mathijs A. Van Dijk

Erasmus University Rotterdam (EUR) ( email )

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

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