Carbon transition risk and stock market premium

This study examines the forecasting ability of carbon transition risk on stock market returns in China by constructing a dedicated index. The findings indicate that carbon transition risk significantly enhances the prediction of market returns. Compared to traditional uncertainty indices and macroeconomic variables, carbon transition risk demonstrates a distinct advantage in forecasting stock returns. Out-of-sample tests further corroborate this result. Additionally, carbon transition risk proves to be of substantial economic value for asset allocation across different risk preferences. The research highlights the heterogeneity in the impact of carbon transition risk on stock returns, showing that its predictive power is stronger in regions with higher pollution levels and more advanced economic development, as well as for larger firms. Robustness tests confirm the stability and reliability of these findings. This study offers investors new strategies for optimizing asset allocation through carbon transition risk and provides valuable insights for policymakers when designing carbon emission reduction policies.