Dissecting Climate Risks: Are they Reflected in Stock Prices?

Abstract

We provide first-time evidence on whether market-wide physical or transition climate
risks are priced in U.S. stocks. Textual and narrative analysis of Reuters climate-change
news over 1 January 2000-31 December 2018, uncovers four novel risk factors related to natural
disasters, global warming, international summits, and U.S. climate policy, respectively.
Only the climate-policy factor is priced, especially post-2012. The documented risk premium
is consistent with investors hedging the imminent transition risks from government
intervention, rather than the direct risks from climate change itself.

Keywords: Physical and transition climate risks, Latent Dirichlet Allocation, Cross-section of stock returns, Textual analysis

JEL Classification: C63, E58, G12, G18, Q5