The Financial Uncertainty of Climate-Related Assets
27 Pages Posted: 6 Apr 2024 Last revised: 23 May 2024
Date Written: March 9, 2024
Abstract
This paper investigates common financial uncertainty across climate-sensitive assets. Using a factor stochastic volatility model, we first construct a new econometric measure of aggregate uncertainty for these assets, then decompose total uncertainty to extract "uncertainty factors", defined as components that reflect common uncertainty shocks across different asset classes. We study the empirical relationship of these uncertainty factors with the option-implied volatility of stocks, distinguishing between green and brown firms. In particular, we find that one uncertainty factor, which loads heavily on commodity markets, appears empirically related to climate issues. This factor is strongly associated with the excess volatility of brown stocks relative to green ones, especially for long option maturities, and exhibits important commonalities with climate news indices. We also show that its relationship with (risk-neutral) option-implied volatility is not driven by time-varying risk aversion nor simply due to commodity market shocks.
Keywords: climate risks, green finance, commodity markets, uncertainty, common factors, stochastic volatility, option markets
JEL Classification: C23, C32, C38, D81, G15, Q02
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