It is recognised that climate risks (including carbon pricing policy) are among the new risk drivers for financial stability. One of the relevant implications of a shock in carbon price is the increase in business costs, which may diminish profitability and affect capital market returns, especially for the most polluting firms.
We propose a modelling framework for medium-term projections of returns of stocks and portfolios under different carbon price scenarios. Specifically, we include a new green factor into the classic capital asset pricing model (CAPM) to capture a firm's exposure to climate policy risks. We then project to 2030 the factors in the CAPM, conditional on different carbon price pathways (released by the Network for Greening the Financial System (NGFS)), using a large Bayesian vector autoregressive (VAR) model. Finally, we project the stock returns of each firm in the portfolio under different carbon price scenarios.
Our results suggest that climate policy risks are not confined to affecting the most polluting firms. However, we estimate that mining and quarrying, transportation, and storage firms are expected to suffer more than those in other sectors, especially under a disorderly transition compared to an orderly transition scenario. These results may represent adequate support for investors to prepare portfolios for such risks in the context of uncertainty regarding the timing of carbon policy introduction. For policymakers, the modelling framework can help understand how policies to prevent or mitigate climate change effects can affect the financial market.
Lorenzo Prosperi is Principal in the Area of Market Analysis and Financial Intermediaries of Prometeia where he is in charge of research projects related to financial Markets, banking and sustainable finance.
He completed his PhD in Economics at Toulouse School of Economics in 2019 and LUISS University in 2015 where he focused on the impact of political frictions and prudential regulation of sovereign exposures on macroeconomic activity. He previously gained Master Degrees in the field of Financial Econometrics and Macroeconomic Theory at the University of Florence, LUISS University and TSE.
The seminar will be held in English.
Major information: Andi Duqi (andi.duqi@unibo.it)