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Factor mimicking portfolios for climate risk


De Nard, Gianluca; Engle, Robert F; Kelly, Bryan (2024). Factor mimicking portfolios for climate risk. Working paper series / Department of Economics 429, University of Zurich.

Abstract

We propose and implement a procedure to optimally hedge climate change risk. First, we construct climate risk indices through textual analysis of newspapers. Second, we present a new approach to compute factor mimicking portfolios to build climate risk hedge portfolios. The new mimicking portfolio approach is much more efficient than traditional sorting or maximum correlation approaches by taking into account new methodologies of estimating large-dimensional covariance matrices in short samples. In an extensive empirical out-of-sample performance test, we demonstrate the superior all-around performance delivering markedly higher and statistically significant alphas and betas with the climate risk indices.

Abstract

We propose and implement a procedure to optimally hedge climate change risk. First, we construct climate risk indices through textual analysis of newspapers. Second, we present a new approach to compute factor mimicking portfolios to build climate risk hedge portfolios. The new mimicking portfolio approach is much more efficient than traditional sorting or maximum correlation approaches by taking into account new methodologies of estimating large-dimensional covariance matrices in short samples. In an extensive empirical out-of-sample performance test, we demonstrate the superior all-around performance delivering markedly higher and statistically significant alphas and betas with the climate risk indices.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Department of Economics
Dewey Decimal Classification:330 Economics
JEL Classification:C58, G11, G18, Q54
Uncontrolled Keywords:Climate change, factor model, portfolio selection, sustainable portfolio
Scope:Discipline-based scholarship (basic research)
Language:English
Date:March 2024
Deposited On:14 Mar 2023 09:59
Last Modified:28 Mar 2024 11:35
Series Name:Working paper series / Department of Economics
Number of Pages:35
ISSN:1664-7041
Additional Information:Revised version
OA Status:Green
Related URLs:https://www.econ.uzh.ch/en/research/workingpapers.html
Other Identification Number:merlin-id:23541
  • Content: Published Version
  • Language: English
  • Permission: Download for registered users
  • Description: Version March 2023
  • Content: Updated Version
  • Language: English
  • Description: Revised version March 2024