Understanding Macro and Asset Price Dynamics During the Climate Transition

Abstract

This paper analyzes the transition to a low-carbon economy and its effects on macroeconomic quantities and asset prices. Empirically, we document that the relative valuation of fossil fuel firms has significantly declined with the rise of climate change risk awareness. We develop a macro asset pricing model for the climate transition that matches this empirical fact and allows us to characterize the dynamics of macroeconomic aggregates and asset prices during and after the transition. In particular, we analyze (i) firm valuation dynamics, (ii) climate policy risk premia, (iii) capital reallocation between sectors, and (iv) the behavior of oil prices.

Keywords: Climate change, Policy risk, General equilibrium, Risk premia, Oil market

JEL Classification: E2, E3, G12, Q43