I am excited to share that our paper Policy Transition Risk, Carbon Premiums, and Asset Prices has been conditionally accepted for publication in the Journal of Monetary Economics. I am very grateful to my dear friend and coauthor Rick van der Ploeg for the excellent cooperation especially especially during those very stressful days in February and far beyond.
In this paper, we analyze the effects of policy transition risk on asset pricing and the green transition using a global two-sector, macro-finance model of climate and the economy. Policy transition risk results from probabilistic changes between three policy states: no, modest, and ambitious carbon pricing. We show that policy transition risk leads to carbon premiums (i.e. higher expected returns on brown than on green assets), especially if the economy is still quite carbon-intensive and close to the temperature cap, and thus accelerate the green transition. Increased transition risk leads to more precautionary saving and falls in the risk-free rate. We offer extensions to deal with physical risks (temperature-related risk of climate disasters and climate tipping), technology transition risk, and more realistic policy tipping with endogenous transition probabilities.
