Both climate change inaction and climate change action are expected to have an impact on the value of financial assets. It is therefore of interest to investors to quantify their exposure to climate change through the use of a climate beta, just as an exposure to market risk is measured by the traditional market beta. However, measuring the climate beta is difficult because it requires identifying a proxy variable that reflects changes in climate risk.
In a new publication "The Impact of Climate Change News on Low-minus-High Carbon Intensity Portfolios", produced as part of the Amundi research chair on "Measuring and Managing Climate Risks in Investment Portfolios," EDHEC-Risk Climate researchers Jean-Michel Maeso and Dominic O'Kane apply the latest natural language processing methods to construct and test such proxies from media articles over some fifteen years.
Linguistic dictionary, lexical sentiment-based techniques, and state-of-the-art transformer-based models are used to capture daily variations in climate change concerns in leading newspapers over the 2005-2021 period. The authors build indices for five major news sources and their aggregation and study the relationship between index innovations and the changes in the values of portfolios of large capitalisation companies listed in the United States.
They draw three major conclusions from their work:
- For most of the language models considered, the sensitivity of returns to an increase in the corresponding aggregated news index is negative and highly statistically significant for portfolios of high carbon intensity stocks, but not significant for portfolios of low carbon intensity stocks. The unexpected arrival of climate news across news sources is generally bad for emissions-intensive assets.
- The average return of portfolios of buying positions in low carbon intensity stocks and selling positions in high carbon intensity stocks consistently rises with the regime (low, medium, high) of the aggregated news index (across all index types), which supports the hypothesis that climate change concerns affect the longer-term performance of such portfolios.
- The value added by advanced approaches relative to a simple attention-based model is modest, indicating either that it is the number of articles, rather than their content, that drives climate risk awareness, or that further progress is needed to better extract sentiment from news sources.
Commenting on this research, Timothée Jaulin, Head of ESG Development & Advocacy at Amundi, added: "Several pioneering papers have examined the link between climate news and equity market returns with a view to isolating "climate beta" that could be used to construct climate-risk hedging portfolios with easy-to-trade assets. This study goes a step further by applying state-of-the-art methods to the task and deriving new insights."
Frédéric Ducoulombier, Director of the EDHEC-Risk Climate Impact Institute, added "Study results are consistent with the intuition that higher carbon intensity activities have higher exposure to the risks arising from climate change and climate change action. The finding that this relationship is statistically significant and of the right sign is good news; however, as in previous studies, the economic impact does not appear significant enough for comfort - one disquieting explanation for investors is that equity prices have yet to adjust to the climate emergency."
A copy of the publication can be downloaded via the following link:
The Impact of Climate Change News on Low-minus-High Carbon Intensity Portfolios, EDHEC-Risk Climate Impact Institute
