Climate-Aware Analysis of Alternative Portfolios

This report describes the research related to use case 3 within pilot ♯6 of the FAME project: Embedding Climatic Predictions in Property Insurance Products.

The changing climate poses risks to the global economy in various ways. In addition to the immediate impacts on the real estate sector, e.g., due to changing living conditions, and impacts on the insurance sector as a result of more frequent and intense weather-related disasters, it calls for the transition to a greener and more sustainable economy, which comes with a significant price tag. While the latter risk cannot be directly related to specific weather events, an increasing body of research suggests that climate risk indices constructed through textual analysis of newspaper articles are able to represent the different types of risks and can thus help build climate risk hedge portfolios.

In this report, we document our own efforts to construct such a news-based climate risk index and analyze whether climate-focused funds perform differently than a benchmark representing the general market. Our risk index is constructed from an analysis of climate change-related newspaper articles in the New York Times which were further filtered by utilizing large language model (LLM) with zero-shot classification. Both full and subcategory-based indices are defined at a daily resolution and were aggregated to both weekly and monthly resolution in order to analyze impacts on stock market returns at different time scales.

Our analysis, however, does not show a clear and robust link between the climate risk index and the stock market returns of climate-focused funds compared to the general market. A more refined selection of ’green’ vs. ’brown’ stocks may be required to see significant, climate risk index-dependent differences in performance that can be exploited for the purpose of portfolio optimization.