Shocks to Transition Risk
32 Pages Posted: 19 Aug 2020
Date Written: July 17, 2020
We propose and implement a method to identify shocks to transition risk. We identify transition risk shocks as instances where a strong differential valuation of green versus brown firms coincides with significant information on climate change. For that purpose, we combine information from long-short equity portfolios sorted on firms' carbon footprints with information from textual analysis of newspaper archives. We find that shocks increasing transition risk (negative abnormal returns of brown firms) induce a decline in aggregate and sectoral industrial production. Moreover, they significantly affect financial stability, as measured by the excess bond premium or credit conditions more generally. Finally, we document a pronounced asymmetry in the economy's response to shocks increasing or decreasing transition risk.
Keywords: transition risk, climate change, financial stability, portfolio sort, textual analysis
JEL Classification: C30, E44, G12, Q43, Q54, Q58
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