Optimal risk management considering environmental and climatic changes

Climate change presents challenges to policy and economic stability, necessitating
effective trading strategies to reduce environmental risks. This article addresses gaps
in existing studies by using a Markov-switching model to consider climate risk. Backward
stochastic differential equations are used to optimize utility with three hedging
strategies based on the concept of risk aversion. Numerical scenarios confirm the
model’s superiority in incorporating exogenous events, with our risk-averse strategy
outperforming classical approaches. Our strategy outperforms classical strategies by
taking a flexible risk trading when investors face risk-averse behavior due to climate
risk events. The findings presented in this article have important implications for the
development of more resilient investment portfolios and can contribute to climate
policy.