Quantifying firm-level carbon risk: A novel emission reduction stress factor

Abstract

This study examines the impact of carbon emission reduction stress (ERS) on stock pricing, addressing a key gap in the climate finance literature concerning the quantification of carbon risk. Using data from 80 of China's top carbon-intensive firms from 2019 to 2022, we apply the Fama–French factor model to test the hypothesis that ERS significantly influences stock returns. Our analysis demonstrates that ERS is a meaningful risk factor, outperforming traditional proxies such as carbon emission levels and emission intensity. The ERS index not only effectively isolates the size effect from emission levels but also captures carbon risk arising from excessive emissions. These findings provide new insights into the pricing of carbon risk in financial markets and offer practical implications for sustainable investment strategies and climate policy, thereby supporting more informed decision-making during the decarbonization of carbon-intensive firm.