Risk Measures for the Climate Transition Age: Why Symmetric Risk Budgets are unlikely to mitigate two-dimensionally asymmetric Climate Change risks

Paper: arXiv 2610.18387

Authors: Lars Dijkstra, Andreas G. F. Hoepner, Fabiola I. Schneider, Agnieszka Słomka-Gołębiowska

Abstract

The most widely used investment risk measures - variance, standard deviation, and tracking error - treat upside deviations as equally undesirable as downside losses. In stable markets with assumed symmetric return distributions, this simplification is potentially harmless. In the climate transition age, it is not. Climate risk is two-dimensionally asymmetric, across assets and over time. Both dimensions are negatively skewed against investors. Hence, climate transition investment strategies deliberately deviate from benchmarks that reflect an insufficiently decarbonising global economy. When fiduciaries enforce tracking error budgets that penalise outperformance just as heavily as underperformance, they inadvertently constrain exactly the portfolio return opportunities that climate-aware investing seeks. We argue that replacing symmetric deviation-based risk measures with their downside-only counterparts - semi-variance, standard risk and trailing error - resolves this conflict without sacrificing any fiduciary discipline. The distinction is not merely semantic: as the gap between climate transition trajectories and market benchmarks widens over the coming decades, symmetric risk budgets will become binding constraints on transition strategies well before actual investment risk warrants it. We propose specific changes to mandate design that would allow institutional investors to pursue climate transition opportunities within genuinely risk-aware (rather than deviation-averse) frameworks.

Complexity vs Empirical Score

• Math Complexity: 3.0/10
• Empirical Rigor: 2.0/10
• Quadrant: Philosophers — conceptual discussion, limited math and data

Why this score: The paper presents a novel conceptual argument regarding risk measures in climate finance, but lacks mathematical derivations or empirical validation. Its strength lies in its clear articulation of a critical issue.

Research Flowchart

  flowchart TD
    A[Research Question: Are symmetric risk budgets appropriate for climate transition risks?] --> B{Critique of Symmetric Risk Measures};
    B --> C[Analysis of Climate Change Risk Asymmetries];
    C --> D{Impact of Symmetric Budgets on Climate Strategies};
    D --> E[Proposed Solution: Downside-Only Risk Measures];
    E --> F[Outcomes: Policy Recommendations for Mandate Design];