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Do Sustainable Investment Strategies Hedge Climate Change Risks? Evidence from Germany's Carbon Tax

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Abstract

It is difficult to assess the effectiveness of investment strategies that screen companies based on environmental criteria to hedge climate change risk because physical risks have not yet fully materialized and policies to combat climate change are usually widely anticipated. This paper sidesteps these limitations by analyzing the stock market response to plausibly exogenous changes in expectations about the level of a carbon tax in Germany. The risk-adjusted return on two sustainable investment approaches---screening companies based on environmental scores and on firms' carbon footprint---around the carbon tax news reveals that firms with a high environmental score did not perform any better than those with a low environmental score. In contrast, the stock price of firms with low carbon emissions increased in value relative to those with a high carbon footprint. Carbon intensity explains the cross-sectional reaction to the carbon tax news because it predicts revisions in expected profitability.

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  • Marcelo Ochoa & Matthias Paustian & Laura Wilcox, 2022. "Do Sustainable Investment Strategies Hedge Climate Change Risks? Evidence from Germany's Carbon Tax," Finance and Economics Discussion Series 2022-073, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2022-73
    DOI: 10.17016/FEDS.2022.073
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    Cited by:

    1. Refk Selmi, 2023. "Do investors care about carbon risk? The impact of the Paris agreement on the inflation hedging performance of commodities," Economics Bulletin, AccessEcon, vol. 43(2), pages 1111-1121.

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    More about this item

    Keywords

    Climate risk; Portfolio choice; Stock returns; Carbon pricing; ESG;
    All these keywords.

    JEL classification:

    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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