Do Investors Care about Carbon Risk?

Do Investors Care about Carbon Risk? Moreover, do carbon emissions affect the cross-section of U.S. stock returns?

Furthermore, 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.

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Written by: Patrick Bolton & Marcin Kacperczykφ

Patrick Bolton is the David Zalaznick Professor of Business. He joined Columbia Business School in July 2005. He received his PhD from the London School of Economics in 1986 and holds a BA in economics from the University of Cambridge and a BA in political science from the Institut d’Etudes Politiques de Paris. Furthermore, he began his career as an assistant professor at the University of California at Berkeley and then moved to Harvard University, joining their economics department from 1987-1989. In addition, he was Chargé de Recherche at the C.N.R.S. Laboratoire d’ Econométrie de L’ Ecole Polytechnique from 1989-1991, Cassel Professor of Money and Banking at the London School of Economics from 1991-1994, Chargé de cours associé at the Institut d’Etudes Europénnes de l’Université Libre de Bruxelles from 1994-1998, and John H. Scully ’66 Professor of Finance and Economics at Princeton University from 1998-2005.

His research and areas of interest are in contract theory and contracting issues in corporate finance and industrial organization. A central focus of his work is on the allocation of control. And decision rights to contracting parties when long-term contracts are incomplete. This issue is relevant in many different contracting areas including: the firm’s choice of optimal debt structure, corporate governance and the firm’s optimal ownership structure, vertical integration, and constitution design. His work in industrial organization focuses on antitrust economics and the potential anticompetitive effects of various contracting practices.

He recently published his first book, Contract Theory. With Mathias Dewatripont and has co-edited a second book with Howard Rosenthal, Credit Markets for the Poor.

Marcin Kacperczyk is a Professor of Finance at the Imperial College London Business School. He is also a Research Fellow at the Centre for Economic Policy and Research. In addition, he serves as an Associate Editor of Financial Management, Management Science, Review of Financial Studies. And Review of Finance, and is a former Research Fellow of the National Bureau of Economic Research.

Professor Kacperczyk’s research focuses mostly on financial markets, financial intermediation, and asset management. His latest work analyses the effects of unconventional monetary policy on asset management industry and corporate sector. He has also written on a broad range of topics. Such as social norms, short-term debt markets, performance evaluation, labour unions, insider trading, income inequality, and portfolio choice. He has analysed various effects of informed trading in finance.

His articles have appeared in Econometrica, Journal of Finance, Journal of Financial Economics, Quarterly Journal of Economics. In addition, Review of Finance and the Review of Financial Studies. As well as non-academic outlets such as Bloomberg, Financial Times, Forbes, New York Times, Wall Street Journal, and Business Week. He has spoken about research on CNBC, CNN, and Bloomberg. He currently holds two highly prestigious research grants: European Research Council Consolidator Grant and Marie Curie Integration Grant.

Professor Kacperczyk has been teaching at Imperial College since 2013. Previously he has been appointed at the University of British Columbia Sauder School of Business. In addition, the New York University Stern School of Business. He obtained a Ph.D. in finance from the Ross School of Business at the University of Michigan. He has received two student awards for Excellence in Teaching as well as two Faculty Excellence Awards from Imperial College.

Do Investors Care about Carbon Risk?

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