Do Investors Care about Carbon Risk?
Do carbon emissions affect the cross-section of U.S. stock returns?
We find that stocks of firms with higher total CO2 emissions (and changes in emissions) earn higher returns, controlling for size, book-to-market, and other return predictors.
We cannot explain this carbon premium through differences in unexpected profitability or other known risk factors.
We also find that institutional investors implement exclusionary screening based on direct emission intensity(the ratio of total emissions to sales) in a few salient industries.
Overall, our results are consistent with an interpretation that investors are already demanding compensation for their exposure to carbon emission risk.
A large asset-pricing literature seeks to explain the cross-sectional pattern of stock returns based on exposures to aggregate risk factors such as size and book-to-market ratios, or firm-specific risk linked to observable firm characteristics.
One variable that has so far been missing from the analysis is corporate carbon emissions.
This omission may be for historical reasons, as concerns over global warming linked to CO2 emissions from human activity have only recently become salient.
But, both the evidence of rising temperatures and the renewed policy efforts to curb CO2 emissions raise the question whether carbon emissions represent a material risk today for investors that is reflected in the cross-section of stock returns and portfolio holdings.
The lack of consensus among institutional investors around climate change naturally raises the possibility that carbon risk may not yet be reflected in asset prices.
To find out, this paper systematically explores whether investors demand a carbon risk premium by looking at how stock returns vary with CO2 emissions caracross firms and industries.
We undertake a standard cross-sectional analysis, asking whether carbon emissions affect cross-sectional U.S. stock returns.