Asset Pricing with Disagreement about Climate Risks
51 Pages Posted: 8 Jun 2023 Last revised: 25 Nov 2024
Date Written: June 8, 2023
Abstract
This paper analyzes how climate risks are priced on financial markets. We show that climate tipping thresholds, disagreement about climate risks, and preferences that price in long-run risks are crucial to an understanding of the impact of climate change on asset prices. Our model simultaneously explains several findings that have been established in the empirical literature on climate finance: (i) news about climate change can be hedged in financial markets, (ii) the share of green investors has significantly increased over the past decade, (iii) investors require a positive, although small, climate risk premium for holding "brown" assets, and (iv) "green" stocks outperformed "brown" stocks in the period 2011-2021. The model can also explain why investments in mitigating climate change have been small in the past. Finally, the model predicts a strong, non-linear increase in the marginal gain from carbon-reducing investments as well as in the carbon premium if global temperatures continue to rise.
Keywords: Asset pricing, carbon premium, climate news, climate risk, heterogeneous beliefs, long-run risk, risk sharing
JEL Classification: G11, G12, Q54
Suggested Citation: Suggested Citation