Carbon Returns across the Globe
The pricing of carbon transition risk is a key question as investors consider climate-aware investments. Accurate risk pricing can support climate change mitigation, potentially reducing the need for heavy-handed government intervention. In theory, brown firms are more exposed to the transition and policy risk and should earn higher expected returns in equilibrium. However, green firms […]
Shaojun Zhang is an Assistant Professor of finance at Ohio State University, Fisher School of Business. This post is based on her article forthcoming in The Journal of Finance.
The pricing of carbon transition risk is a key question as investors consider climate-aware investments. Accurate risk pricing can support climate change mitigation, potentially reducing the need for heavy-handed government intervention. In theory, brown firms are more exposed to the transition and policy risk and should earn higher expected returns in equilibrium. However, green firms can outperform in the transition to the net-zero economy when policy shocks kick in, consumer attention turns, and investor tastes shift. Alternatively, if investors do not materially pay attention to carbon footprint, we would not observe significant outperformance by either green or brown firms. Despite substantial interest, both academics and practitioners continue to debate the extent to which financial markets have priced in carbon transition risk.
In this paper, I revisit the carbon return—the return spread between brown and green firms. The measure of carbon transition risk is the carbon intensity or emissions per unit of sales, and emissions data are only available to investors with significant lags. After accounting for the data release lag, the carbon return is significantly negative in the U.S. It varies considerably across countries following climate preference shifts and variations in climate policy tightness. Overall, the evidence suggests that the transition to full carbon-aware pricing is still early and underway.
