Pricing Climate Change Exposure

We estimate the risk premium for firm-level climate change exposure among S&P 500 stocks, and its time-series evolution between 2005 to 2020. Exposure reflects the attention paid by market participants in earnings calls to a firm’s climate-related risks and opportunities. When extracted from realized returns, the unconditional risk premium is insignificant but exhibits a positive risk premium period before the financial crisis and a steady increase thereafter. Forward-looking expected return proxies deliver an unconditionally positive risk premium, with maximum values of 0.5% to 1% (depending on the proxy) between 2011 and 2014. The risk premium is lower since 2015, especially if the expected return proxy explicitly accounts for the higher opportunities and the lower crash risks that characterize high-exposure stocks. This finding arises as the priced part of the risk premium primarily originates from climate-related upside opportunities, rather than downside physical or regulatory risks. In the time series, the risk premium is negatively associated with green innovation, Big Three holdings, and ESG fund flows, and positively with climate adaptation programs.

Other authors: Zacharias Sautner, Laurence van Lent and Ruishen Zhang (Frankfurt School of Finance & Management).