Integration of Environmental Factors into Portfolio Risk Assessment

Abstract

The financial sector collectively cannot hedge all climate-related risks, and investors individually are unlikely to affect climate developments significantly. However, the financial sector can help channel savings into green projects and thus facilitate divestment from heavy-carbon-footprint producers. This article provides a novel framework for understanding climate-related adaptation, mitigation, and transition risks and outlines a method for valuing these risks in institutional investor portfolios. The authors’ proposed setup serves as a continuous call to action to long-term institutional investors to obtain accurate information on climate-related risks and develop appropriate frameworks for understanding these risks, regularly valuing them, and properly incorporating them into their investment decisions. <b>TOPICS:</b>ESG investing, tail risks, portfolio management/multi-asset allocation <b>Key Findings</b> ▪ This article provides a novel framework for understanding climate-related adaptation, mitigation, and transition risks. ▪ It outlines a method for valuing climate-related risks in institutional investor portfolios. ▪ It stresses the importance of integrating environmental factors in portfolio risk assessment by obtaining accurate information on climate-related risks and developing appropriate frameworks.