The Impact of Climate Change Risk on Long-term Asset Allocation
30 Pages Posted: 20 Dec 2023 Last revised: 26 Dec 2023
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: Suggested Citation
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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