The Impact of Climate Change Risk on Long-term Asset Allocation

30 Pages Posted: 20 Dec 2023 Last revised: 26 Dec 2023

See all articles by Jean-Charles Bertrand

Jean-Charles Bertrand

HEC Paris - Finance Department

Guillaume Coqueret

EMLYON Business School

Nicholas McLoughlin

HSBC Global Asset Management

Stephane Mesnard

HSBC Global Asset Management

Date Written: December 21, 2023

Abstract

We propose a framework for long-term cross-asset portfolio choice in which the estimation of the covariance matrix is subject to climate risk. We model the future volatility and correlation of assets as a linear function of three types of forward-looking variables: their long-term future average, climate-aware projections of economic indicators, and scenarios for the temperature anomaly. We analyze the shifts from a baseline 60/40 equity/bond allocation when taking climate risk into account. We find that these changes are small and mostly favorable to bonds if the focus is on the estimation of risk components. Including climate-driven expected returns in the optimization substantially alters the compositions, but this time to the benefit of equities. In all cases, the risk-adjusted returns decrease, often significantly, when taking climate impact into account.

Keywords: Asset allocation, climate change

JEL Classification: G11, C53, Q54

Suggested Citation

Bertrand, Jean-Charles and Coqueret, Guillaume and McLoughlin, Nicholas and Mesnard, Stephane, The Impact of Climate Change Risk on Long-term Asset Allocation (December 21, 2023). Available at SSRN: https://ssrn.com/abstract=4666471 or http://dx.doi.org/10.2139/ssrn.4666471

Jean-Charles Bertrand

HEC Paris - Finance Department ( email )

1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
France

Guillaume Coqueret (Contact Author)

EMLYON Business School ( email )

23 Avenue Guy de Collongue
Ecully, 69132
France

Nicholas McLoughlin

HSBC Global Asset Management ( email )

78 St. James's Street
London, London SW1A 1EJ
United Kingdom

Stephane Mesnard

HSBC Global Asset Management ( email )

78 St. James's Street
London, London SW1A 1EJ
United Kingdom

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