Structural Change and the Climate Risk Premium during the Green Transition

Sophie Zhou, Frederick (Rick) van der Ploeg and Rick van der Ploeg

No 10840, CESifo Working Paper Series from CESifo

Abstract: We study climate change in a model with a carbon-intensive and a green sector, each subject to stochastic sectoral productivity shocks, and show how the underlying economic structure affects the risk-adjusted discount rate and the climate risk premium in the social cost of carbon (SCC). Consumption growth, aggregate consumption volatility, and the climate beta are all affected by the elasticity of substitution between the two sectors and the relative size of the sectors, and vary as the green transition progresses. The climate risk premium is hump-shaped during the green transition, with the climate beta playing a dominant role in its magnitude. For sufficiently strong substitutability between the two sectors and sufficiently low correlation between the sectoral shocks, decarbonisation can temporarily reduce aggregate consumption risk, as the climate beta becomes negative in the mid phase of the transition. The risk-adjusted discount rate first falls then rises during the green transition, leading to a SCC to GDP ratio that rises then falls as the green sector grows. We illustrate our analytical results numerically.

Keywords: social cost of carbon; climate beta; carbon risk premium; two-sector model; asset pricing (search for similar items in EconPapers)
JEL-codes: E60 G12 H23 O41 Q54 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-ene, nep-env and nep-upt
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Related works:
Working Paper: Structural change and the climate risk premium during the green transition (2024)
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Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_10840

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