28 January 2025
Over the past decade, rising concerns about global warming and climate-related risks have heightened interest in their financial market implications. Recent research suggests that climate risk is a systematic factor influencing stock returns. While strategies to hedge climate uncertainty remain underexplored, some studies propose de-carbonized equity portfolios. Lavinia Rognone and her co-authors expand the literature by examining the safe-haven potential of green assets, including green bonds, alongside precious metals, against transition and physical climate risks identified through textual analysis.
Key findings indicate that green bonds provide consistent safe-haven benefits for both types of climate risk, with positive time-varying correlations to climate risk proxies. This positions green bonds as effective tools for mitigating climate-driven uncertainty, which commands a risk premium in equity markets.
Climate risk impacts stock returns through two channels: physical risks, stemming from climate hazards disrupting operations and cash flows, and transition risks, arising from, e.g., costs associated with regulatory shifts toward low-carbon economies, primarily affecting energy-intensive industries. These risks have heterogeneous effects, and the non-diversifiable nature of climate risk underscores the importance of identifying assets that can hedge against these uncertainties, as investors increasingly demand compensation for climate risk exposures.
Read the full paper: Hedging climate risks with green assets
Full paper reference: Cepni, O., Demirer, R., and Rognone, L. “Hedging climate risks with green assets”. Economic Letters. Economics Letters, Volume 212, 2022.
Lavinia Rognone is Lecturer in Sustainable Finance at the University of Edinburgh Business School.