Transition versus physical climate risk pricing in European financial markets: a text-based approach

We examine the existence of physical and transition climate risk premia in euro areaequity markets. To do so, we develop two novel physical and transition risk indicators, basedon text analysis, which are then used to gauge the presence of climate risk premia. Resultssuggest that climate risk premia for both, transition and physical climate risk, have increasedsince the time of the Paris Agreement. In addition, we investigate which metrics may be usedby investors to proxy a firm’s exposure to either physical or transition risk. To this end, weconstruct portfolios according to the most common firm-specific climate metrics and estimatethe sensitivity of these portfolios to our risk indicators. We compare results from these firmlevelproxies to much simpler sectoral classifications to see if investors may simply pigeonholefirms into the industry they operate in. We find that firm level information appears to beused as a gauge for transition risk, in particular since 2015, whereas sectoral classificationsappear insufficient. However, sectoral classification may be employed to broadly gauge firms’exposures to physical risk. JEL Classification: C58, G12, G14, G28, Q51