From Pledges to Portfolios: Integrating Countries' Climate Commitments into Sovereign Bond Investments

Fabio Alessandrini, Eric Jondeau and Lou-Salomé Vallée
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Fabio Alessandrini: University of Lausanne; Banque Cantonale Vaudoise
Eric Jondeau: University of Lausanne - Faculty of Business and Economics (HEC Lausanne); Swiss Finance Institute
Lou-Salomé Vallée: University of Lausanne - Faculty of Business and Economics (HEC Lausanne)

No 25-22, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This paper explores the integration of Nationally Determined Contributions (NDCs) into the construction of net-zero (NZ) portfolios of sovereign bonds. Based on both backward-looking (2015-2021) and forward-looking (2021-2030) analyses, we compare the effectiveness of scenarios using constant greenhouse gas (GHG) intensities and NDC-based trajectories in reducing the portfolio's GHG intensity while minimizing the tracking error relative to the business-as-usual benchmark. The backward-looking exercise reveals that NDC-based portfolios achieve similar GHG intensity reductions with lower tracking errors compared to constant-intensity scenarios, demonstrating their efficacy in building an NZ portfolio. Conversely, constant-intensity strategies require more aggressive rebalancing, leading to higher tracking errors and uneven allocations. In the forward-looking exercise, the more ambitious second round of NDCs announced before COP26 enables substantial GHG intensity reductions at a marginal financial cost. Overall, our results highlight the potential of NDCs as a forward-looking tool to align sovereign bond portfolios with climate objectives while maintaining financial performance. However, imposing weight restrictions by country or region, to ensure more equitable investment between advanced and emerging economies, significantly limits the ability to meet reduction targets and increases tracking errors.

Keywords: Net-zero investment; Sovereign bond portfolio; Portfolio carbon footprint; Climate change; Nationally determined contributions (search for similar items in EconPapers)
JEL-codes: G11 Q56 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2025-03
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