78 Pages Posted: 10 Mar 2017 Last revised: 19 Aug 2020
Date Written: August 10, 2020
We investigate carbon risk in global equity prices. We develop a measure of carbon risk using industry standard databases and study return differences between brown and green firms. We observe two opposing effects: Brown firms are associated with higher average returns, while decreases in the greenness of firms are associated with lower announcement returns. We construct a carbon risk factor-mimicking portfolio to understand carbon risk through the lens of a factor-based asset pricing model. While carbon risk explains systematic return variation well, we do not find evidence of a carbon risk premium. We show that this may be the case because of: (1) the opposing price movements of brown firms and firms becoming greener, and (2) that carbon risk is associated with unpriced cash-flow changes rather than priced discount-rate changes. We extend our analysis to different geographic regions and time periods to confirm the missing risk premium.
Keywords: Carbon risk, climate finance, climate change, economic transition, asset pricing
JEL Classification: G12, G15, Q51, Q54
Suggested Citation: Suggested Citation