Pricing Climate Transition Risk: Evidence from China’s Carbon Neutrality Pledge

Abstract

We study the pricing of climate transition risk. Exploiting China’s 2021 carbon neutrality pledge as an increase in economy-wide transition risk, and using firm-level variation in investors’ carbon-related information demand as a proxy for exposure to such risk, we document that firms with more exposure to transition risk experience higher annual stock returns after the pledge. Using a large language model (LLM) for topic classification, we find that our results are primarily driven by variation in information demand related to green innovation, products and services, and managers’ carbon transition plans. In addition, we find that firms facing investor information demand related to these topics also experience increased annual stock return volatility following the 2021 carbon neutrality pledge. Our results support asset pricing theories in which carbon transition risk leads to higher returns. 

Keywords: ESG, climate-related disclosure, net-zero pledges, climate transition risk, stock returns

JEL Classification: D62, G18, M40, Q40, Q56, G12