The Carrot and the Stock: In Search of Stock-Market Incentives for Decarbonization

IMF Working Papers, November 18, 2022

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Canonical URL: The Carrot and the Stock: In Search of Stock-Market Incentives for Decarbonization

Financial markets can support the transition to a low-carbon economy by redirecting funds from highly emissive to clean investments.
Using a novel dataset of stock prices and carbon intensities of 338 European publicly traded companies between 2013 and 2021, the authors find a strongly statistically significant relationship between weekly carbon price changes and stock returns.
The relationship between carbon price changes and stock returns depends on firms’ carbon intensity: the higher the carbon costs a firm faces, the poorer its stock performance during periods of carbon price increases.
Emissions covered with free allowances do not affect this relationship.

Stock markets discriminate between firms with different carbon intensities when carbon prices change, creating a stock-market incentive channel for decarbonization.
The presence of free allowances mutes the price signal, indicating that both carbon pricing and disclosures are needed for financial markets to foster climate change mitigation.
The identified relationship can provide firms with an incentive to decarbonize through market valuation effects.

The authors argue in favor of more ambitious carbon pricing policies, because:
- stronger carbon pricing would strengthen the stock-market incentive channel for decarbonization;
- such policies would cause only limited financial stability risk for stocks.