Essays in Climate Change and Finance

My first paper studies how firms' environmental performances affect cross-sectional expected stock returns and investments. Using a third-party ESG score, I find that greener stocks have lower expected returns. This greenium remains significant after controlling for systematic and idiosyncratic risks. Green stocks hedge climate-related disasters, contributing to the greenium. A macro-finance integrated assessment model featuring time-varying climate damage intensity, recursive preferences, and investment frictions quantitatively explains the empirical findings. The model implies a positive covariance between climate damages and consumption, which justifies a high discount rate and a low present value of carbon emission. The second paper is a joint work with Shasha Li, a former colleague at Bocconi University who is now an assistant professor at the Halle Institute for Economic Research. We study how the attention allocation of green-motivated investors changes information asymmetry in financial markets and thus affects firms' financing costs. To guide our empirical analysis, we propose a model where an investor with green taste endogenously allocates attention to market or firm-specific shocks. We find that more green-motivated investors tend to give more attention to green firm-level information instead of market-level information. Thus higher green taste leads to less category learning behavior and reduces the information asymmetry. Furthermore, it suggests that higher green taste results in lower leverage and lower cost of capital of green firms. The last paper is a proposal that applies the information theory on climate change. I study how a better information about climate evolution and feedback in the future affects current actions to mitigate carbon emissions. This proposal improves previous studies on the precautionary principal, by extending the traditional method to rank information structures by Blackwell (1966) to a less strict but more versatile method by Lehmann (1988). This study could help policymaker better decide the timing of climate mitigation when facing decreased future uncertainty.