The impact of greenhouse gas aversion on optimal portfolios

Anatoly B. Schmidt

Abstract

In this paper, the notion of greenhouse gas aversion (GHGA) is introduced into the mean–variance portfolio framework. GHGA is assumed to be a weighted sum of the portfolio holdings’ greenhouse gas emission intensities. A new portfolio performance measure, the GHGA-tilted Sharpe ratio, is offered for greenhouse-gas-averse investors. While the classical Sharpe ratio may monotonically decrease with growing GHGA, the GHGA-tilted Sharpe ratio has a maximum at intermediate values of GHGA, defining an optimal GHGA-based mean–variance portfolio. The main holdings of such a portfolio represent promising investment leads for socially responsible investors who do not want to abandon the “brown” industries altogether. An example of a GHGA-based mean–variance portfolio formed with the major constituents of the energy sector is discussed.