Haibo Liu
Purdue University
Title
Do Low Internal Carbon Prices Signal Climate Inaction? A Financed-Emissions Perspective
Abstract
Using a low internal carbon price (ICP) is often viewed as evidence of climate inaction. Yet firms in the financial services and insurance industries adopt some of the lowest ICPs across all sectors, far below the ranges recommended by leading international climate bodies. In this paper, we rationalize these low ICPs by focusing on their financed emissions, which account for the vast majority of the total emissions for financial institutions. We develop and analytically solve an extended mean-variance model with a constraint on portfolio emissions. Our model identifies an emission-efficient frontier (EEF) for environmentally conscious investors. We use the EEF to analyze the expected impact of an internal carbon policy and show that the policy is most effective when brown assets yield only modest performance. Using emissions data from London Stock Exchange Group, we empirically estimate the EEF. According to our model, to maximize the firm’s carbon-adjusted Sharpe ratio, the ICP should not exceed $4.5 per tonne. Meanwhile, the estimated expected policy impact is high, and hence even a low ICP can reduce the firm’s financed emissions substantially with little compromise in investment performance. Our findings support the use of low ICPs for financed emissions and call into question the practices of benchmarking ICPs uniformly across emission scopes against the price ranges recommended by the climate bodies.