Climate-Aware Risk Budgeting

Vol. 20, No. 4, 2022
by Brian Jacobsen, Eddie Cheng and Wai Lee

Climate change is a risk investors are thinking about, but how can it be practically incorporated into an asset allocation framework? This paper presents two different approaches. One is a traditional approach where the covariance matrix and excess return vector is adjusted to account for climate change. More detail is given for a second approach, a risk-budgeting approach. In this approach, investors adjust their risk budgets based on climate change information.