Pricing Climate Risk
45 Pages Posted: 10 Dec 2019
Date Written: December 9, 2019
I exploit a new dataset from Four Twenty Seven and identify physical climate risk factors that can explain the variation in global individual stock returns. North American stocks are currently exposed to an extreme rainfall factor and an overall climate risk factor. European and Japanese stocks are currently exposed to an extreme rainfall factor, a heat stress factor, and an overall climate risk factor. I assess the pricing of policy related to these risks by drawing on new data from the Transition Pathway Initiative that summarises publicly-available information on a firm's emissions and targets. Physical climate risk and transition risk factors cannot explain the returns of portfolios sorted on standard accounting variables (such as investment, momentum and profitability), and vice-versa. However, a quality factor can explain both climate-related and non-climate-related portfolios. Climate risks may be mispriced and quality captures a confounding association between the environment and the zoo of factors used to explain asset returns.
Keywords: Climate Risk, Physical Risk, Transition Risk, Asset Pricing, LASSO
JEL Classification: G12, G14, Q51, Q54
Suggested Citation: Suggested Citation