The Impact of Climate Change Risk on Global Investments: A portfolio and investor study of climate change risk in the U.S. and Europe

Abstract

The physical and transition risks of climate change on financial investments have become increasingly discussed in the financial world, but lack academic research into the topic. Therefore, the aim of this study is to investigate how climate change impacts the investment decision of capital market actors. The study combined a quantitative portfolio study with a qualitative interview approach to increase the external validity of the study. In the portfolio analysis, two mutually exclusive portfolios with different climate change characteristics were composed for the U.S. and European market respectively between 2010-2016. Monthly performance data was used to estimate the Capital Asset Pricing Model (CAPM) and the Carhart four-factor model. The high-ranked U.S. portfolio significantly outperformed the lowranked. The same result was found in the European market although not significant. The findings suggest a positive relation between climate change risk and stock performance. In addition, seventeen interviews were conducted with representatives from asset managers, banks and institutional investors in Austria, Denmark, Germany, Sweden and Switzerland. The findings suggest that capital market actors consider climate change as a financial risk, partly driven by customer pressure and reputation risk. Positive and negative screens or a best-in-class approach are already used to include climate change into the investment process. Individual financial markets will be influenced differently as their exposure to companies impacted by climate change differs. The lack of transparent and consistent data and political uncertainty was identified as the major obstacles to be overcome in the further integration of climate change into the investment process. To conclude,climate change influences the investment decision of capital market actors by introducing additional financial risk concerns that diverge between national financial markets.