Dirty Business: Transition Risk of Factor Portfolios

Among U.S. public firms, the 12.5% most carbon-intensive accounted, on average, for over 90% of aggregate Scope 1 emissions from 2010 to 2024. These heavy emitters averaged roughly 40% of Fama–French Big Value’s market capitalization but 5% of Big Growth’s. Because Value–Growth is a first-order source of expected-return variation, we estimate the incremental transition-risk premium within Big Value by splitting it into heavy- and light-emitter subportfolios. Raw and risk-adjusted returns do not differ significantly between heavy and light emitters. By contrast, heavy-minus-light spreads in two forward-looking measures, implied cost of capital (ICC) and option implied expected-return lower bounds, widen after the 2015 Paris Agreement, although significance varies across weightings and subperiods, suggesting a small, time-varying incremental transition-risk premium. Among light emitters (similar environmental characteristics, different fundamentals), Big Growth outperformed Big Value, and its ICC moved further below Big Value’s, showing that climate concerns alone cannot explain Value’s recent underperformance.