Greenness Confusion and the Greenium

Abstract

Investors’ appetite for green finance increased considerably in particular after the Paris Agreement. However, the lack of a standardized definition of green and non-green activities represents a main obstacle to understand under which conditions a green portfolio may outperform the market. We investigate to what extent the European stock market prices climate transition risk, testing different classifications of “green” and “high-carbon” used by investors and financial authorities, including Greenhouse gas emissions intensity and carbon footprint, ESG, the EU Taxonomy, and the science-based classification Climate Policy Relevant Sectors (CPRS). As a difference from standard market-based classifications, the CPRS takes into ac- count forward-looking dimensions of climate transition risk exposure, i.e. energy technology profile, fossil input substitutability and cost of policy and regulation. We develop portfolios and green-minus-brown factors and we analyse the market pricing in an augmented CAPM and Fama-French models. The results confirm that different classifications lead to very different evidence on greenium, i.e. higher expected returns for high-carbon assets w.r.t. green assets. Interestingly, we find that the existence of a greenium disappears when considering forward-looking climate risk characteristics captured by combining the CPRS and the EU Taxonomy. Our approach allows for better hedging of climate transition risk emerging from pol- icy and regulatory announcements, and to consider policy uncertainty in climate- aligned portfolio construction.

Keywords: Greenium, green-minus-brown factors, asset pricing, sustainable finance classifications, transition risk, climate policy.

JEL Classification: G10, G12, G14, G15