Carbon dioxide risk exposure: Co2Risk

Abstract

The release of carbon dioxide into the atmosphere is the main driver of global warming and a threat that is becoming particularly important to the financial markets. The long-term, structural and systemic impact of global warming could damage the real economy and financial stability through different channels. This paper explores the co-movement between carbon price changes, as a short term indicator of global warming, and U.S. stock returns along the full conditional distribution of industry portfolios through a Carbon Dioxide Risk exposure measure, Co2Risk, inspired by the financial systemic risk literature. We find evidence of a sign-switching sensitivity at different quantiles, which implies that the uncertainty surrounding carbon risk seems to have an asymmetric impact on the industry conditional distributions. We find that drastic increases in carbon prices (positive changes in emissions) reduce the risk exposure during bear markets, but increase it during bullish scenarios. We also find that large polluter sectors show greater sensitivity to changes in carbon emissions.