Optimizing portfolios under carbon risk constraints: Setting effective constraints to favor green investments

An Chen; Leonard Gerick; Zhuo Jin

doi:10.1016/j.eneco.2025.108634

Optimizing portfolios under carbon risk constraints: Setting effective constraints to favor green investments

An Chen, Leonard Gerick^*, Zhuo Jin

^*Corresponding author for this work

Department of Actuarial Studies and Business Analytics

Research output: Contribution to journal › Article › peer-review

9 Citations (Scopus)

128 Downloads (Pure)

Abstract

Climate change and its concomitant adaptations pose significant challenges for companies and confront them with new risks. Investors must consider these risks when shaping their investment portfolio. This study investigates portfolio optimization under a carbon risk constraint in an expected utility framework. To illustrate the implications of the carbon risk constraint, we consider a financial market with only one risk-free and two risky assets, one green and one brown. We identify conditions under which the imposition of the carbon risk constraint leads to an increase in the green investment and a decrease in the brown investment. Surprisingly, an increased investment in the brown asset can also be optimal under certain conditions. Further, we employ different carbon risk metrics, such as carbon intensity and Brown-Green-Score, to compare the resulting optimal portfolios.

Original language	English
Article number	108634
Pages (from-to)	1-17
Number of pages	17
Journal	Energy Economics
Volume	148
DOIs	https://doi.org/10.1016/j.eneco.2025.108634
Publication status	Published - Aug 2025

Bibliographical note

© 2025 The Authors. Published by Elsevier B.V. Version archived for private and non-commercial use with the permission of the author/s and according to publisher conditions. For further rights please contact the publisher.

Keywords

Carbon risk management
Carbon risk metric
Climate change
Environmental risk constraint
Sustainable investing
Utility maximization

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10.1016/j.eneco.2025.108634Licence: CC BY

Publisher version (open access)Final published version, 2.17 MBLicence: CC BY

Cite this

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title = "Optimizing portfolios under carbon risk constraints: Setting effective constraints to favor green investments",

abstract = "Climate change and its concomitant adaptations pose significant challenges for companies and confront them with new risks. Investors must consider these risks when shaping their investment portfolio. This study investigates portfolio optimization under a carbon risk constraint in an expected utility framework. To illustrate the implications of the carbon risk constraint, we consider a financial market with only one risk-free and two risky assets, one green and one brown. We identify conditions under which the imposition of the carbon risk constraint leads to an increase in the green investment and a decrease in the brown investment. Surprisingly, an increased investment in the brown asset can also be optimal under certain conditions. Further, we employ different carbon risk metrics, such as carbon intensity and Brown-Green-Score, to compare the resulting optimal portfolios.",

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AB - Climate change and its concomitant adaptations pose significant challenges for companies and confront them with new risks. Investors must consider these risks when shaping their investment portfolio. This study investigates portfolio optimization under a carbon risk constraint in an expected utility framework. To illustrate the implications of the carbon risk constraint, we consider a financial market with only one risk-free and two risky assets, one green and one brown. We identify conditions under which the imposition of the carbon risk constraint leads to an increase in the green investment and a decrease in the brown investment. Surprisingly, an increased investment in the brown asset can also be optimal under certain conditions. Further, we employ different carbon risk metrics, such as carbon intensity and Brown-Green-Score, to compare the resulting optimal portfolios.

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KW - Sustainable investing

KW - Utility maximization

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Optimizing portfolios under carbon risk constraints: Setting effective constraints to favor green investments

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