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Are financial markets pricing the net zero carbon transition? A reconsideration of the carbon premium

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  • Gasparini, Matteo

Abstract

Previous research has highlighted a positive correlation between realised returns and carbon emissions. This paper shows that this carbon premium might be partially due to mispricing produced by climate policy uncertainty. For this reason, realised returns may not be representative of expected returns. To show this, I develop an asset pricing model with uncertain expectations about the future cash flows of fossil-fuel firms; the price-dividend ratio increases with uncertainty about a climate policy regime shift. I confirm this proposition empirically using data on analysts' forecasts; I find that analysts' forecast disagreement, as a proxy for climate policy uncertainty, may explain part of the valuations of a large sample of fossil-fuel stocks. Using my model, I show with forward-looking scenarios that cash flow expectations implied in the valuations of fossil-fuel firms may be inconsistent with a net zero carbon transition.

Suggested Citation

  • Gasparini, Matteo, 2023. "Are financial markets pricing the net zero carbon transition? A reconsideration of the carbon premium," INET Oxford Working Papers 2023-23, Institute for New Economic Thinking at the Oxford Martin School, University of Oxford.
    • Handle: RePEc:amz:wpaper:2023-23
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    More about this item

    Keywords

    Asset Pricing; Uncertainty; Climate Finance; Climate Change;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects

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