Dissecting Green Returns

Abstract

Green assets delivered high returns in recent years. This performance reflects unexpectedly strong increases in environmental concerns, not high expected returns. German green bonds outperformed their higher-yielding non-green twins as the greenium widened, and U.S. green stocks outperformed brown as climate concerns strengthened. To show the latter, we construct a theoretically motivated green factor -- a return spread between environmentally friendly and unfriendly stocks - and find that its positive performance disappears without climate-concern shocks. A theory-driven two-factor model featuring the green factor explains much of the recent underperformance of value stocks. Our evidence also suggests small stocks underreact to climate news.