Carbon Beta: A Market-Based Measure of the Carbon Risk Exposure of European Equities Between 2015-2023

Abstract

This thesis aims to provide insights into the climate transition risk exposure of European equities by quantifying it through a market-based measure. It constructs a climate risk factor termed Pollutive Minus Clean to capture systemic transition risk and derives carbon betas, reflecting individual stock sensitivities to this factor. The Pollutive Minus Clean factor is constructed by sorting firms based on their relative CO₂ emissions, and carbon betas are estimated through a rolling window multiple regression framework that builds on the Fama and French three-factor model, the Carhart four-factor model, and the Fama and French five-factor model, each extended with the climate risk factor. The empirical analysis covers companies in the STOXX Europe 600 index over the period from 2015 to 2023. This study contributes to the growing field of climate finance, which has so far been largely overrepresenting the United States. It also addresses the lack of quantitative measures for assessing firm-level climate transition risk, which remains a significant challenge for institutional investors seeking to manage and hedge such risk. Hence, the objective of this study is to determine the extent to which the market-based measure carbon beta can capture firm-level exposure to climate transition risk among European equities in the STOXX Europe 600 index over the 2015-2023 period. The findings show that carbon beta is a useful but limited measure for assessing climate transition risk among European equities. While it captures some sectoral and firm-specific patterns, its explanatory power is weak, which can largely be attributed to current CO₂ emissions data limitations and arguably to the unique climate-related regulatory environment of the EU. Nonetheless, it offers a valuable foundation for further research into market-based climate risk measures tailored to the European markets.