Climate risk definition and measures: asset pricing models and stock returns

The aim of this study is to examine the literature on climate risk definition and measures and the impact of climate risk on stock returns. We review how asset pricing models (and their testable implications) consider climate risk as a residual systemic risk driver in excess of either standard market risk factors or latent factors identified with business and financial cycles. Firms less exposed to transition risk, in equilibrium, should face a lower cost of equity financing, given an expected return lower than the one associated with pollutant firms. The existence of a recent outperformance of realized returns on green stocks can be reconciled with unexpected shifts in investors tastes for green assets. Finally, we identify some issues regarding the empirical approach and suggest several potential areas for future research.