Explaining Greenium in a Macro-Finance Integrated Assessment Model

Abstract How do firms’ environmental performances affect cross-sectional expected stock returns? Using a third-party ESG score, I find that greener stocks have lower expected returns. This greenium remains significant after controlling for systematic and idiosyncratic risks. Green stocks hedge climate-related disasters, contributing to the greenium. A macro-finance integrated assessment model featuring time-varying climate damage intensity, recursive preferences, and investment frictions quantitatively explains the empirical findings. The model implies a positive covariance between climate damages and consumption, which justifies a high discount rate and a low present value of carbon emission.