The Impact of Carbon Emissions on US Stock Returns: An empirical study of how carbon intensity impacts financial performance

Abstract

The aim of this thesis is to research what effect carbon emissions have on a company's financial performance in the stock market. We want to examine if investing in greener portfolios can yield returns equal to more carbon heavy portfolios with a larger environmental footprint. Historically such investing strategies have been linked with perceived increased risk and lower return, making it challenging to convince investors to invest more sustainably. In recent years there has been a growing interest amongst investors to incorporate different environmental and societal criteria into their investment strategy. Socially responsible investing is increasing, and ESG factors are becoming a benchmark for evaluating company performance as well as financial performance. This is mainly due to a change in society's values and their expectations of how large firms should operate. It is also a response to tackling the effects of climate change, where companies are a crucial part of mitigating these effects. In order to conduct our research this thesis will use the observed companies' carbon intensity scores and examine whether there is a significant difference in low carbon and high carbon intensity portfolios in terms of risk adjusted return for shareholders. We focus on the US stock market from 2007 to 2018. We construct two portfolios that are composed of stocks with low and high carbon-intensity levels respectively. Moreover, we employ OLS regressions and are applying the CAPM and the Fama French five factor model to identify the different risk exposures and potential abnormal return that exists within the portfolios. We supplement the regressions by performing a mean-variance analysis of the portfolios and calculate the risk-adjusted returns. Our results indicate no significant abnormal return for either the low carbon-intense portfolio, or the high carbon-intense portfolio, although we observe clear differences between the portfolios in terms of their risk exposure to the respective FF-factors. From the mean-variance portfolio analysis we observe that the optimal weighting of the FF-factors differ between the carbon-portfolios, and that the analysis yielded no significant difference between the risk-adjusted returns for the respective portfolio. This indicates that the implied shadow price on green capital - the price of green investing - is near zero.