Asset Diversification versus Climate Action

Abstract

Asset pricing and climate policy are analyzed in a global economy
where consumption goods are produced by both a green and a carbon-intensive
sector. We allow for two types of damages from global warming. Given that the
economy is initially heavily dependent on carbon-intensive capital, the desire to
diversify assets complements the attempt to mitigate economic damages from
climate change. In the longer run, however, a trade-off between diversification
and climate action emerges. We derive the optimal carbon price, the equilibrium
risk-free rate, and risk premia. Climate disasters, which are more likely to occur
sooner as temperature rises, significantly increase risk premia on financial
assets.
Keywords

Keywords: decarbonization, diversification, carbon price, asset prices, green assets, disaster risk

JEL Classification: D81, G01, G12, Q5, Q54