Climate Change and Uncertainty: An Asset Pricing Perspective

Abstract

Climate change and uncertainty about its potential consequences has become a central concern for economists, investors, and policymakers alike. I use a stochastic, dynamic general equilibrium model where final output is produced using a mix of cheap, dirty inputs and expensive, clean inputs and preferences incorporate aversion to climate model misspecification to analyze the implications of climate change and climate model uncertainty on economic and financial market outcomes. I find that climate change leads to increased clean input production and reduced emissions and that there is a negative price of climate risk that is significantly amplified and increasing in magnitude as climate change increases due to aversion to climate model uncertainty. Existing empirical estimates are consistent with the model implications, highlighting the potentially significant influence of climate model uncertainty on macroeconomic and asset pricing outcomes. This paper was accepted by Elke Weber, Special Section of Management Science on Business and Climate Change. Funding: This work was supported by the Energy Policy Institute at Chicago [Dissertation Support Fellowship], the Fama-Miller Center [Liew Fama-Miller Fellowship], the National Science Foundation [Graduate Research Fellowship Award D], and the University of Chicago [Harper (Provost) Dissertation Fellowship]. Supplemental Material: The data files and online appendices are available at https://doi.org/10.1287/mnsc.2022.4635 .