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Blind to carbon risk? An analysis of stock market reaction to the Paris Agreement

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  • Monasterolo, Irene
  • de Angelis, Luca

Abstract

It is increasingly recognized that a transition to sustainable finance is crucial to scale up the low-carbon investments needed to achieve the global climate targets. A main barrier to portfolios' decarbonization is the lack of conclusive evidence on whether low-carbon investments add value to a portfolio, and on whether markets react to climate announcements by rewarding (penalizing) low-carbon (carbon-intensive) assets. To fill this gap, we develop an empirical analysis of the low-carbon and carbon-intensive indices for the EU, US and global stock markets. We test if financial markets are pricing the Paris Agreement (PA) by decreasing (increasing) the systematic risk and increasing (decreasing) the portfolio weights of low-carbon (carbon-intensive) indices afterwards. We find that after the PA the correlation among low-carbon and carbon-intensive indices drops. The overall systematic risk for the low-carbon indices decreases consistently, while stock markets' reaction is mild for most carbon-intensive indices. Moreover, the weight of the low-carbon indices within an optimal portfolio tends to increase after the PA. This evidence suggests that stock market investors have started to consider low-carbon assets as an appealing investment opportunity after the PA but have not penalized yet carbon-intensive assets.

Suggested Citation

  • Monasterolo, Irene & de Angelis, Luca, 2020. "Blind to carbon risk? An analysis of stock market reaction to the Paris Agreement," Ecological Economics, Elsevier, vol. 170(C).
    • Handle: RePEc:eee:ecolec:v:170:y:2020:i:c:s0921800919309607
    DOI: 10.1016/j.ecolecon.2019.106571
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    More about this item

    Keywords

    Asset pricing; Paris Agreement announcement; Low-carbon indices; Carbon-intensive indices; Systematic risk; Markowitz's portfolio optimization; Market model; Fama-French five-factor model; Risk-adjusted return; Stranded assets;
    All these keywords.

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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