“Brown” Risk or “Green” Opportunity? The dynamic pricing of climate transition risk on global financial markets

There is mixed evidence about the pricing of climate transition risk on financial markets. I contribute to this debate methodologically by measuring firms' climate transition risk with a sector/technology classification. Thereby, I complement approaches relying on contested ESG and incomplete CO2 data. Moreover, I contribute empirically by comparing the pricing of brown and green pure-play companies in the time-series and cross-section. By focusing on companies' technologies, I find that green stocks outperform significantly in the time-series. The annual outperformance of green vs. brown stocks of ∼20 % is higher than previous estimates and very robust. Interestingly, the green outperformance accelerated after the Paris Agreement, suggesting that green stocks benefited from an unexpectedly strong increase in transition risk concern. I also calculate a technology-based Brown Minus Green Factor, which exhibits low correlations with other factors. Using the Fama and MacBeth (1973) procedure, I find initial evidence that the factor is negatively priced in the cross-section of returns. Through propensity score matching, I finally show that brown firms carry substantially higher forward-looking dividend yields, indicating that investors expect higher payouts for holding riskier assets.