By Alexander Cheema-Fox, George Serafeim, and Hui (Stacie) Wang.
Substantial physical impacts from climate change are already happening around the world and are expected to accelerate in the next few decades.
Using measures of physical risk from climate change, we develop a methodology to allocate currency pairs according to a country’s vulnerability to climate change. In turn, we use this to demonstrate how investors can construct portfolios with decreasing vulnerability to physical risk. During our sample period of 2002 to 2019, physical risk-resilient portfolios with decreasing vulnerability generated positive excess returns that were predominately driven by emerging market currencies. Our study provides early evidence of how investors could use liquid FX instruments and climate change fundamentals to manage physical risk and preserve asset values in domestic and foreign currencies.