Foundations of Climate Investing: How Equity Markets Have Priced Climate-Transition Risks

Countries have set varying targets to reduce greenhouse gas emissions in line with the Paris Agreement's goal of keeping the increase in global average temperatures to well below 2 degrees C. In this article, the authors examine to what extent climate risk has been priced into equity markets and whether climate change can be modeled using a typical risk model structure. They develop the fundamental economic transmission channels to explain the potential impact of climate change on equity prices, including empirical evidence for climate policies and green technology as financial risk drivers. They also study the impact of climate-transition risk on valuation levels and trends. They conclude with a discussion of how to measure and categorize companies' climate-risk exposures and how to integrate climate-transition risks into risk models.