Green portfolio optimization: A scenario analysis and stress testing based novel approach for sustainable investing in the paradigm Indian markets
In this article, we present a novel approach for the construction of an environment-friendly green portfolio using the ESG ratings, and application of the modern portfolio theory to present what we call as the ``green efficient frontier'' (wherein the environmental score is included as a third dimension to the traditional mean-variance framework). Based on the prevailing action levels and policies, as well as additional market information, scenario analyses and stress testing are conducted to anticipate the future performance of the green portfolio in varying circumstances. The performance of the green portfolio is evaluated against the market returns in order to highlight the importance of sustainable investing and recognizing climate risk as a significant risk factor in financial analysis.
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