Transition Versus Physical Climate Risk Pricing in Euro Area Financial Markets: A Text-Based Approach
Year: 2021
Type: preprint
Abstract: This study analyses the pricing of climate risk in equity markets. To this end, we first collect authoritative and scientific texts on the topic of physical and transition risk and build two novel vocabularies. Following, we apply the cosine-similarity approach suggested by Engle et al. 2020 to compare both vocabularies with a corpus of European daily news and construct two novel physical and transition climate risk indices covering the period 2005-2021. Finally, these time series are integrated into an asset pricing model to test the sensitivity of daily equity returns to climate shocks, controlling for several climate exposure metrics. Our results suggest that news on physical risk and transition risk carry relevant information which is reflected in asset prices. Firms with poor environmental and Environmental, Social, and Governance (ESG) performances, as well as firms with high Greenhouse Gas (GHG) emissions underperform when transition risk rises. Analogously, excess returns of firms with low environmental and ESG scores decline in the event of physical risk news. While investors appear to penalise high climate risk exposure, no evidence of outperformance of less exposed firms can be found, suggesting negative screening as a predominant investment strategy.
Source: SSRN Electronic Journal
Authors: Giovanna Bua, Daniel S. Kapp, Federico Ramella, Lavinia Rognone
Institutions: European Central Bank, University of Manchester
Language: English
Subfield: Finance
Domain: Social Sciences
SDG: Climate action
Open Access status: green
OpenAlex ID: W3170332007