Explaining Greenium in a Macro-Finance Integrated Assessment Model

Abstract

I investigate how firms' environmental responsibilities affect expected stock returns. Using the environmental pillar score from the ASSET4 ESG dataset, I find that greener stocks have lower expected returns. This greenium remains significant after controlling for systemic and idiosyncratic risks. I explain the greenium through event studies showing that green stocks hedge physical climate-change risks. A macro-finance integrated assessment model (MFIAM) featuring time-varying climate damage intensity, recursive preferences, and investment frictions supports the empirical findings. The model implies that climate damages are pro-cyclical, leading to a high discount rate and a relatively low social cost of carbon.