This report explores optimal combinations of financial and hedging instruments to support sustainable investments in the medium and long term. Through six interrelated analyses, it examines how climate risk can be priced and mitigated. Each study offers insight into how financial markets can evolve to more effectively support the transition to a sustainable economy.   

We begin by examining green bonds as an emerging strategic asset class. An analysis of their dynamic dependencies, allocation potential, and diversification properties—both before and during the COVID-19 pandemic—reveals that green bonds offer meaningful diversification benefits and resilience during periods of market stress. These characteristics position them as valuable components of medium- and long-term sustainable investment strategies. A critical component of sustainable finance is the interpretation of ESG ratings, which are often used to guide investment decisions. The report investigates the ambiguity and signaling value of ESG scores, proposing an informative and distorted signal-based approach. This analysis shows that while ESG ratings can provide valuable information, they are also prone to inconsistencies and noise. Misaligned or ambiguous ratings can distort capital allocation and risk assessment, underscoring the need for greater methodological transparency and convergence in ESG scoring frameworks.

We then turn to the analysis of water scarcity, a key source of physical climate risk, and of potential methods of water risk mitigation. The issue is studied from two perspectives. First, novel physical and financial hedging are introduced, which are able to mitigate water shortage impacts. These instruments can address the growing need for targeted financial instruments in vulnerable regions and sectors. The second perspective is that of risk management, and the work illustrates the use of weather derivatives as a hedging tools to manage cash flow volatility linked to climate-related water stress, under a number of climate change scenarios described by the RCP pathways. Empirical modeling supports the effectiveness of these instruments for utilities, agriculture, and water-intensive industries. Next, the impact of climate risk — both transition and physical — in equity and debt markets is evaluated. The analysis shows partial but increasing integration of transition risk into corporate valuations, while the pricing of physical risk is more pronounced in the fixed income sector rather than in equity. This suggests significant room for improvement in climate risk transparency and valuation methodologies across capital markets.

Afterwards, to enhance hedging effectiveness in a world dependent on energy, the report introduces an advanced approach to modeling energy commodity futures and futures on the carbon allowances of the Emissions Trading Scheme of the European Union, using realized volatility. Accurate volatility modeling is essential for pricing risk and developing tailored hedging strategies, particularly in energy commodities markets affected by supply-chain disruptions, regulatory shifts, and environmental shocks. The links and transmission channels across commodities are also investigated, to increase the understanding of the complex system of interactions and substitution effects across energy inputs. Finally, once again on the topic of energy, machine learning techniques are applied to analyze how renewable energy generation, electricity prices, and power load collectively influence CO2 emissions, focusing on France, Germany, and Italy. The objective of the study is to inform policymakers and stakeholders about effective strategies for emission reduction and sustainable energy planning. Ultimately, this analysis contributes to broader efforts aimed at achieving economic sustainability through cleaner energy systems and supports Europe's ambitious targets for reducing greenhouse gas emissions.

Taken together, these analyses highlight the importance of a layered and comprehensive approach to financing sustainable investments. Strategic asset allocation (potentially involving green bonds and accounting for climate risk and ESG ambiguity), novel weather-based risk mitigation tools (weather derivatives), climate risk pricing, and an accurate modelling of energy commodities and CO2 emissions all play essential roles. No single perspective can fully address the complexity of climate risk and sustainable finance, but an integrated combination of hedging tools and analyses offers the most effective pathway toward a resilient and sustainable financial system.