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This paper proposes a mean-variance optimization and portfolio frontier analysis of energy risk management with carbon assets, introduced in January 2005 as part of the EU Emissions Trading Scheme. In a stylized exercise, the authors compute returns, standard deviations and correlations for various asset classes from April 2005 to January 2009. This central result features an expected return of 3% with a standard deviation < 0.06 by introducing carbon assets - carbon futures and CERs-in a diversified portfolio composed of energy (oil, gas, coal), weather, bond, equity risky assets, and of a riskless asset (U.S. T-bills). Besides, they investigate the characteristics of each asset class with respect to the alpha, beta, and sigma in the spirit of the CAPM.
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