Green transition, investment horizon, and dynamic portfolio decisions

Abstract

This paper analyzes the implications of investors’ short-term oriented asset holding and portfolio decisions (or short-termism), and its consequences on green investments. We adopt a dynamic portfolio model, which contrary to conventional static mean-variance models, allows us to study optimal portfolios for different decision horizons. Our baseline model contains two assets, one asset with fluctuating returns and another asset with a constant risk-free return. The asset with fluctuating returns can arise from fossil-fuel based sectors or from clean energy related sectors. We consider different drivers of short-termism: the discount rate, the nature of discounting (exponential vs. hyperbolic), and the decision horizon of investors itself. We study first the implications of these determinants of short-termism on the portfolio wealth dynamics of the baseline model. We find that portfolio wealth declines faster with a higher discount rate, with hyperbolic discounting, and with shorter decision horizon. We extend our model to include a portfolio of two assets with fluctuating returns. For both model variants, we explore the cases where innovation efforts are spent on fossil fuel or clean energy sources. Detailing dynamic portfolio decisions in such a way may allow us for better pathways to empirical tests and may provide guidance to some online financial decision making.

Financing the green transition. The role of macro-economic policies in ensuring a just transition

“…In the past, such shifts in the sources of energy production have been shown to lead to significant financial market disruptions (Kennedy, 2023). A fast transition to carbon neutrality is likely to lead to a re-assessment of wealth ("stranded assets") with consequences for portfolio investment decisions, the value of collateral and banking sector stability (Semmler et al, 2022;Hengge et al, 2023). At the same time, rising costs of climate change, for instance in the form of natural disasters, will also affect the financial sector stability, in particular through its impact on premiums for (re-)insurance companies.…”