Abstract
Sustainable finance, which integrates environmental, social and governance criteria on financial decisions rests on the fact that money should be used for good purposes. Thus, the financial sector is also expected to play a more important role to decarbonise the global economy. To align financial flows with a pathway towards a low-carbon economy, investors should be able to integrate into their financial decisions additional criteria beyond return and risk to manage climate risk. We propose a tri-criterion portfolio selection model to extend the classical Markowitz’s mean-variance approach to include investor’s preferences on the portfolio carbon risk exposure as an additional criterion. To approximate the 3D Pareto front we apply an efficient multi-objective genetic algorithm called ev-MOGA which is based on the concept of -dominance. Furthermore, we introduce a-posteriori approach to incorporate the investor’s preferences into the solution process regarding their climate-change related preferences measured by the carbon risk exposure and their loss-adverse attitude. We test the performance of the proposed algorithm in a cross-section of European socially responsible investments open-end funds to assess the extent to which climate-related risk could be embedded in the portfolio according to the investor’s preferences.
Highlights
Climate change will pose a challenge for the financial sector seeking a balance between purely financial goals—looking for high returns—and sustainability making a positive impact on the environment and society
As stated in this report, to date, environmental and climate risks had not been appropriately considered by the financial sector, which is why if the EU wants to reorient capital flows to a more sustainable economy, environmental and social goals will have to be included in the financial decision-making
The main contributions of this paper are summarized as follows: (i) We propose an approach based on a recent multi-objective genetic algorithm called ev-MOGA [6] to assess and manage the impact of climate-change related risk including as a third objective a new measure of carbon risk based on the low carbon designation (LCD) benchmark provided by Morningstar
Summary
Climate change will pose a challenge for the financial sector seeking a balance between purely financial goals—looking for high returns—and sustainability making a positive impact on the environment and society. Public Health 2020, 17, 6324 should ask their clients’ investments objectives as regard sustainability and take their preferences into account when providing financial advice This implies that investors should be able to integrate into their financial decisions additional criteria beyond return and risk and to extend the classical bi-criterion portfolio selection problem based on Markowitz’s mean-variance approach [2] by adding one more criterion. The main contributions of this paper are summarized as follows: (i) We propose an approach based on a recent multi-objective genetic algorithm called ev-MOGA [6] to assess and manage the impact of climate-change related risk including as a third objective a new measure of carbon risk based on the LCD benchmark provided by Morningstar.
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