DP13730 Hedging Climate Change News

Author(s): Robert F Engle III, Stefano W Giglio, Bryan Kelly, Heebum Lee, Johannes Ströbel
Publication Date: May 2019
JEL(s): G11, G18, Q54
Programme Areas: Public Economics, Financial Economics, Development Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13730

We propose and implement a procedure to dynamically hedge climate change risk. We extract innovations from climate news series that we construct through textual analysis of newspapers. We then use a mimicking portfolio approach to build climate change hedge portfolios. We discipline the exercise by using third-party ESG scores of firms to model their climate risk exposures. We show that this approach yields parsimonious and industry-balanced portfolios that perform well in hedging innovations in climate news both in sample and out of sample. We discuss multiple directions for future research on financial approaches to managing climate risk.