Measuring and Optimizing the Risk and Reward of Green Portfolios
Posted: 24 Aug 2022
Date Written: August 17, 2022
We study the performance of green portfolios in both the US and Chinese markets, constructed using a broad range of climate-related environmental metrics, including carbon emissions, water consumption, waste disposal, land and water pollutants, air pollutants, and natural resource use. We compare several popular long-only and long-short green portfolio construction methodologies, and find that a method based on Treynor-Black weights offers the most robust performance, thanks to its ability to quantify alphas for individual assets based on a small number of parameters. In the US, green portfolios (e.g., low-carbon portfolios) realize positive alphas in excess of Fama-French factors, of which a significant portion can be explained by an unexpected increase in climate concerns over the last decade, rather than positive expected returns. In China, investors bear a cost for holding green assets instead of brown assets over the last seven years, implying a positive carbon premium, opposite to the US market.
Keywords: Climate Finance; Carbon Neutrality; Environmental, Social, and Governance (ESG); Portfolio Construction; China
JEL Classification: C10, C20, G11, G12
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