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Climate Change Investment Risks: Exploring the Implications for Optimal Portfolio Construction

Climate change caused by man-made greenhouse gas emissions is rising rapidly up the agendas of decision-makers worldwide. Carbon pricing is already a feature of economic regulation in Europe and being piloted elsewhere. While investors attempts to use carbon emissions data to reduce this climate transition risk have been unsatisfactory we find that in fact investors can substantially reduce their exposure to carbon pricing without altering the risk-return trade-off targeted by an investor by using the methodology presented. The financial costs of hedging carbon pricing scenarios are found to be statistically negligible.