The strategy uses LDA-analyzed news topics to construct risk factors, sorting U.S. equities into deciles by climate policy beta, creating monthly value-weighted long-short portfolios based on topic shares.
ASSET CLASS: stocks | REGION: United States | FREQUENCY:
Monthly | MARKET: equities | KEYWORD: Climate, News
I. STRATEGY IN A NUTSHELL
Uses LDA on 7M news articles to construct topic-based risk factors for 4,700 U.S. stocks (2000–2018). Stocks are sorted monthly by their beta exposure to topics (e.g., climate policy), forming value-weighted long-short decile portfolios.
II. ECONOMIC RATIONALE
Climate-related risks are exogenous and partially independent of traditional factors, causing investors to reprice exposed stocks. Shifts in sentiment or policy tightenings trigger asset repricing, making climate-topic betas a distinct driver of returns beyond conventional risk factors.
III. SOURCE PAPER
Dissecting Climate Risks: Are they Reflected in Stock Prices? [Click to Open PDF]
Renato Faccini, Danmarks Nationalbank; Rastin Matin, PFA Asset Management; George Skiadopoulos, University of Piraeus, Department of Banking and Financial Management; Queen Mary, University of London, School of Economics and Finance
<Abstract>
We provide first-time evidence on whether market-wide physical or transition climate risks are priced in U.S. stocks. Textual and narrative analysis of Reuters climate-change news over 1 January 2000-31 December 2018, uncovers four novel risk factors related to natural disasters, global warming, international summits, and U.S. climate policy, respectively. Only the climate-policy factor is priced, especially post-2012. The documented risk premium is consistent with investors hedging the imminent transition risks from government intervention, rather than the direct risks from climate change itself.
IV. BACKTEST PERFORMANCE
| Annualised Return | 12.15% |
| Volatility | 16.79% |
| Beta | N/A |
| Sharpe Ratio | 0.72 |
| Sortino Ratio | N/A |
| Maximum Drawdown | N/A |
| Win Rate | N/A |
