How much do investors care about carbon emissions? Why markets may want to price climate risk ?
These topics are elaborated on a new study published by Houdou Basse Mama (ESCP Business School) and Rahel Mandaroux (Potsdam Institute for Climate Impact Research) disseminated by the World Economic Forum (WEF) last March 20, 2023.
Yesterday's post "How (and why) to Build a Circular Economy" also related to WEF, but refering to a report from another organization, the Circle Economy. Also great, by the way.
Continuing today's post, we quote:
"In the context of growing environmental consciousness, are investors still willing to put their money in ‘dirty’ industries with costly externalities? As ESG (environmental, social and governance) aspects are more and more often factored into financial analysis, perhaps investors view carbon emissions as a material risk that needs to be priced?"
This line of thoughs highlights critical elements nowadays. More specifically:
extra costs associated with carbon emissions
several climate risks that potentially have negative effects on firm value
policies and regulations in place to fight climate change
concerns about the uncertain future cost of emitting
transition and the risk of technology obsolescence
financiers pricing returns on uncertain stock markets
more environmentally-minded funds ‘greening’ their portfolios
The research focused on the European Union. Three portfolios – ‘clean,’ ‘medium’ and ‘dirty’ - were constructured based on the carbon emission measures of the sample firms and matched with emissions data, including allocated emission permits.
For our readers involved with portfolio modelling, the study confirmed the "expected U-shaped relation between CO2 emissions and 1-year-ahead market valuations with a valuation that increased with emissions, then decreased beyond a certain threshold. Specifically, the annualised abnormal return was substantially larger for the medium portfolio than for the clean or dirty one (Sharpe ratios - a reference risk-adjusted performance measure - were respectively 0.47, 0.19 and 0.12)."
Putting it simple: "Firms that emit more than their industry peers, on average, trade at a discount of 37.5%, while firms that emit less than their industry peers trade at fair value on average."
Click at the image below to access the research https://onlinelibrary.wiley.com/doi/10.1002/bse.2886 at Wiley Online Library. And here for the WEF article.
