Blind to Carbon Risk? An Analysis of Stock Market’s Reaction to the Paris Agreement

19 Pages Posted: 27 Dec 2018 Last revised: 29 Oct 2019

See all articles by Irene Monasterolo

Irene Monasterolo

Boston University; Vienna University of Economics and Business

Luca De Angelis

University of Bologna - Department of Economics

Date Written: December 9, 2018

Abstract

It is increasingly recognized that a transition to sustainable finance is crucial to scale up the low-carbon investments needed to achieve the global climate targets. A main barrier to portfolios’ decarbonization is the lack of conclusive evidence on whether low-carbon investments add value to a portfolio, and on whether markets react to climate announcements by rewarding (penalizing) low-carbon (carbon-intensive) assets. To fill this gap, we develop an empirical analysis of the low-carbon and carbon-intensive indices for the EU, US and global stock markets. We test if financial markets are pricing the Paris Agreement (PA) by decreasing (increasing) the systematic risk and increasing (decreasing) the portfolio weights of low-carbon (carbon-intensive) indices afterwards. We find that after the PA the correlation among low-carbon and carbon-intensive indices drops. The overall systematic risk for the low-carbon indices decreases consistently, while stock markets’ reaction is mild for most of carbon-intensive indices. Moreover, the weight of the low-carbon indices within an optimal portfolio tends to increase after the PA. This evidence suggests that stock market investors have started to consider low-carbon assets as an appealing investment opportunity after the PA but have not penalized yet carbon-intensive assets.

Keywords: asset pricing, Paris Agreement announcement, low-carbon indices, carbon-intensive indices, systematic risk, Markowitz’s portfolio optimization, market model, Fama-French five-factor model, risk-adjusted return, stranded assets

JEL Classification: C22, C58, Q54

Suggested Citation

Monasterolo, Irene and De Angelis, Luca, Blind to Carbon Risk? An Analysis of Stock Market’s Reaction to the Paris Agreement (December 9, 2018). Available at SSRN: https://ssrn.com/abstract=3298298 or http://dx.doi.org/10.2139/ssrn.3298298

Irene Monasterolo (Contact Author)

Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

Luca De Angelis

University of Bologna - Department of Economics ( email )

Bologna
Italy

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