Hedging climate change news

Author / Creator

Engle, R. F. (Robert F.), author

Available as

Online

Summary

We propose and implement a procedure to dynamically hedge climate change risk. To create our hedge target, we extract innovations from climate news series that we construct through textual analysis...

We propose and implement a procedure to dynamically hedge climate change risk. To create our hedge target, we extract innovations from climate news series that we construct through textual analysis of high-dimensional data on newspaper coverage of climate change. We then use a mimicking portfolio approach based on a large panel of equity returns 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. The resulting hedge portfolios outperform alternative hedging strategies based primarily on industry tilts. We discuss multiple directions for future research on financial approaches to managing climate risk.

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