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Climate Change and Its Impacts on Asset Pricing and Investing

Climate Change and Its Impacts on Asset Pricing and Investing

INDUSTRY TRENDS AND RESEARCH

With climate change and ESG investing all over the news, a recent white paper by Dimensional assesses the academic literature on climate science, and economics and finance, including the implications of climate change for asset pricing and investment choices.

Overall, the literature provides compelling evidence that the impact of climate change risk on asset prices is captured well through the valuation framework, suggesting that investors can use current prices and reliable proxies for expected future cash flows to identify and pursue systematic differences in expected returns, according to Dimensional’s paper, “The Economics of Climate Change.”

The 32-page paper first reviews the basics of climate science and the historical evolution of greenhouse gas emissions, and then discusses the relation between climate change and economics, and assesses the economic costs—direct and indirect—of climate change. It then turns to the tradeoffs associated with different potential actions, such as carbon taxation and cap-and-trade programs, with a final examination of the implications of climate change for asset pricing and investment choices.

“Measures of climate risk might be useful for the pursuit of higher expected returns only if they contain reliable information about the cross section of expected returns beyond the information contained in current prices and profitability,” explain authors Mathieu Pellerin, Jacobo Rodriguez and Joseph Chi.

They further note that there is a growing body of evidence showing that prices across many different markets—stocks, bonds, climate futures, equity options and real estate—incorporate information about climate risk.

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