Carbon Returns and Risk Premia in a Macro-Finance Model for the Climate Transition

Abstract

This paper proposes a macro-finance model to characterize asset prices, risk premia, and macroeconomic quantities over the climate transition. The calibrated model shows that it is excessively difficult to quantify carbon premia based on stock returns realized since the start of the transition. In contrast, one can very well pin down since when and by how much firm valuations were affected through the combined cash flow and risk premium effects. Applying the model insights to the oil sector, we find that relative oil firm valuations have declined by more than 40% since the year 2000 with the proceeding climate transition.

Keywords: climate change, carbon premia, policy risk, macro-finance, oil firms

JEL Classification: E2, E3, G12, Q43