Pricing on Carbon Transition Risks: Carbon Emission Trading and Stock Returns

Relying on the phased rollout of the carbon emission trading (CET) pilot policy, we estimate a staggered difference‐in‐differences (DID) model to identify how transition risks induced by carbon pricing policies are priced in stock returns. Our results show that after CET implementation, stocks of CET‐covered firms command a significant carbon risk premium, providing empirical support for the carbon risk premium hypothesis. The premium arises from the market pricing of three distinct cash‐flow risks triggered by CET: operational uncertainty, credit deterioration, and information asymmetry. Meanwhile, divestment by rational investors serves as a key transmission channel for the premium. Dynamic analysis reveals pronounced time variation in the premium: it is significant during the initial period, persists for two years after implementation, then gradually attenuates, and reappears after the national CET launch. We further find that exposure to these risks is partially captured by established market factors (size/SMB, value/HML, profitability/RMW), indicating that carbon risk itself does not constitute a standalone pricing factor. Third‐party verified environmental ratings account for a substantial fraction of the cross‐sectional variation, whereas self‐disclosed environmental information by firms has limited explanatory power, indicating that information asymmetry constrains the market's ability to price carbon transition risks. This study provides microlevel evidence on how carbon policies are transmitted through capital markets.