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 period with a positive risk premium 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%-1% p.a., depending on the proxy, between 2011 and 2014. The risk premium has been lower since 2015, especially when the expected return proxy explicitly accounts for the higher opportunities and lower crash risks that characterize high-exposure stocks. This finding arises as the priced part of the risk premium primarily originates from uncertainty about climate-related upside opportunities. In the time series, the risk premium is negatively associated with green innovation; Big Three holdings; and environmental, social, and governance fund flows and positively associated with climate change adaptation programs.

Automated summary

This study estimates the risk premium for S&P 500 stocks with climate change exposure and examines its time-series evolution from 2005 to 2020. The research finds that the unconditional risk premium is insignificant, but there was a positive risk premium period before the financial crisis, followed by a steady increase. Forward-looking expected return proxies show a positive risk premium between 2011 and 2014. Since 2015, the risk premium has been lower, especially when considering the high opportunities and lower crash risks of high-exposure stocks.