Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/222582
Authors: 
Karydas, Christos
Xepapadeas, Anastasios
Year of Publication: 
2019
Series/Report no.: 
Economics Working Paper Series 19/327
Abstract: 
There are concerns that climate-related physical and political risks are not yet properly reflected in asset prices. To address these concerns, we develop a dynamic asset pricing framework with two sources of rare disasters: macroeconomic events and climate change. We link carbon emissions and portfolio composition with the stochastically-varying probability of climate-related events. Using theory and simulations we study the implications of the imminent threat of climate change on different market measures and on the participation of carbon-intensive assets in the market portfolio. We also obtain closed-form solutions for market prices and the Social Cost of Carbon. Our results suggest that climate change implies a positive and increasing risk premium. We also show that, with the observed trends in climate change, macroeconomic risk works as a hedge against catastrophic climate change, such that the aggregate equity premium may remain unaltered. The transition risk of climate policy substantially lowers the participation of carbon-intensive assets in the market portfolio.
Subjects: 
Climate change
Risk premia
Rare events
Policy Risk
Stranded assets
JEL: 
G11
G12
O44
Q51
Q54
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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