Will Climate Change Crash the Stock Market?

TL;DR

Climate change poses risks to investors and asset prices. Green assets may hedge climate risk, but may also have lower expected returns. Evidence suggests that climate risk is priced in the market.

Transcript

• Climate risk is a concern for many investors. And for good reason, there has been an unprecedented surge in economic development over the last 200 years largely driven by the power of fossil fuels. We've correspondingly seen rising levels of carbon dioxide and other greenhouse gases in our atmosphere and an increase in the global means surface te... Read More

Key Insights

• 👨‍💼 Climate change poses physical and transitional risks to businesses, communities, and the economy, potentially affecting asset valuations.
• 😘 Green assets may hedge climate risk, but they also have lower expected returns due to investor preferences.
• 🏛️ Evidence suggests that climate risk is priced in the market, reflected in various asset classes like weather futures, municipal bonds, real estate, and corporate bonds.
• 😘 Investing in green assets may offer a hedge against climate risk, but it comes with lower expected returns.
• 💚 Total market index funds, rather than focusing only on green companies, may be a more suitable approach to manage climate risk while maximizing returns.
• ✳️ The world's largest asset managers are addressing climate risk through engagement and proxy voting, contributing to the management of climate risks in the market.

Questions & Answers

Q: How does climate change affect asset prices?

Climate change poses physical and transitional risks, reducing expected cash flows and increasing discount rates for affected businesses, which can lower asset valuations.

Q: Why do green assets have lower expected returns?

Green assets have lower expected returns because investors prefer owning companies that generate positive externalities for society and hedge climate risk, which leads to lower expected returns as investors accept lower yields.

Q: Is climate risk priced in the market?

Yes, there is evidence that climate risk is priced in asset prices. Studies on weather futures contracts, municipal bonds, real estate, options market, and corporate bonds show that climate risk affects pricing and yields.

Q: Should investors build portfolios that heavily invest in carbon-intensive firms?

It may not be advisable to overweight carbon-intensive firms to increase expected returns. Studies suggest that climate risk does not provide additional information about expected returns beyond existing risk factors like firm size, relative price, and profitability.

Summary & Key Takeaways

• Climate change creates physical and transitional risks for businesses, communities, and the economy, potentially affecting asset prices.

• Physical risks include changing weather patterns and areas becoming uninhabitable due to temperature or flooding.

• Transitional risks arise from consumer demands for lower carbon impact and government regulations, creating uncertainty for businesses.