Spectral Climate Risk

In this study, we analyze the role played by shocks to climate concern in driving the return performance of a green-minus-brown (GMB) portfolio designed to hedge climate risk. While previous studies conduct their analysis in the time domain, we use the extended Wold decomposition, which allows us to work in the time-frequency domain, and we explore, after controlling for traditional market risk factors, how the sensitivity of portfolio returns to shocks to climate concern varies across investment horizons of different lengths. The empirical evidence, based on a U.S. portfolio, shows an outperformance of green stocks larger than the one suggested by time-domain analysis and occurring with a delay that manifests over a four- to eight-day horizon. Moreover, our findings suggest that, among the three main categories of climate change risk (physical, transition, and liability), heightened concern about transition risk is the most important factor driving the observed outperformance of the green portfolio.