Enni Kanerva 

The relationship between stock returns and 
climate change concerns in different regions 

 

 

 

 

 

 

 

 

  Vaasa 2025 

School of Accounting and Finance  
Master’s thesis 

Finance Programme 



2 

UNIVERSITY OF VAASA 
School of Accounting and Finance  
Author:    Enni Kanerva 
Title of the Thesis:  The relationship between stock returns and climate change 
concerns in different regions 
Degree:    Master’s Degree 
Programme:   Finance 
Supervisor:   Nebojsa Dimic 
Year:    2025 Sivumäärä: 103 

ABSTRACT: 
The purpose of this thesis is to examine the relationship between climate change concerns and 
stock returns in different regions. The chosen regions for the evaluation are the USA, Europe, 
and the Nordic countries. The sample consists of data for the period 1.1.2010-31.5.2024. For the 
examination, two simple linear regression models are constructed. These Models aim to 
elaborate how the Media Climate Change Concern (MCCC) index affects the returns of stock 
indices in different regions. In addition, with thematic climate change concern indices, it is 
possible to locate which type of concerns have the most significant effect on returns. Lastly, 
additional analysis is performed by analyzing how the relationship has evolved as attention 
towards climate change has strengthened.  
 
This thesis is motivated by the growing importance of sustainability and climate change as 
critical global challenges that impact economic systems and financial markets. Traditional and 
behavioral finance theories, which elaborate the basis of stock price formation on the market, 
provide a theoretical background for this thesis. Also, the importance of climate risks for 
investors and the consistent development of sustainability justifies the materiality of climate 
change concerns. Furthermore, supporting the objective of this thesis.  
 
The results of this thesis are mainly aligned with the presented hypotheses. The increase of 
climate change concerns has a negative impact on the stock returns in most of the regions. Also, 
in the USA, Finland, and Sweden evidence is found that the negative impact on the returns is 
strongest for the transition risk related climate change concerns. Whereas, in Europe, Denmark, 
and Norway the climate change concerns linked to physical risks have the strongest negative 
impact on the stock returns. These results confirm a recognizable relationship between climate 
change concerns and stock returns. The regional differences would indicate that the importance 
of climate change concerns varies depending on the region, which can be further traced back to 
the sustainability differences of the regions. This has important implications for the risk 
management of investors. While providing information on the importance of climate change 
concerns to policymakers and companies. 
 
 
 
 
 

KEYWORDS: climate change, climate risk, socially responsible investing (SRI), sustainability, 
ESG, stock returns, investor attention, risk management, the Paris Agreement, the Nordics 

  



3 

TIIVISTELMÄ:  
 
Tämän tutkielman tarkoituksena on tarkastella ilmastonmuutoshuolien ja osaketuottojen välistä 
yhteyttä eri alueilla. Tutkimuksen kohteeksi valitut alueet ovat Yhdysvallat, Eurooppa ja 
Pohjoismaat. Tutkittavaksi ajanjaksoksi on valittu 1.1.2010–31.5.2024. Tutkimusta varten 
laadittiin kaksi lineaarista regressiomallia, joiden avulla analysoitiin Media Climate Change 
Concern (MCCC) -indeksin vaikutusta osakeindeksien tuottoihin eri alueilla. Lisäksi 
ilmastonmuutoshuolien teemajaottelun avulla pystyttiin tunnistamaan, millaisilla huolenaiheilla 
on merkittävin vaikutus osaketuottoihin. Lopuksi tutkielmassa suoritettiin lisäanalyysi, jossa 
tarkasteltiin, miten tämä suhde on kehittynyt ajan kuluessa, kun ilmastonmuutokseen 
kohdistuva huomio on kasvanut. 
 
Tämä tutkielma saa motivaationsa kestävän kehityksen ja ilmastonmuutoksen kasvavasta 
merkityksestä, mitkä keskeisinä haasteina vaikuttavat laajasti talouteen sekä 
rahoitusmarkkinoihin. Teoreettisena taustana tutkielmassa hyödynnetään sekä perinteisiä että 
käyttäytymistieteellisiä rahoitusteorioita, jotka selittävät osakehintojen muodostumisen 
perusteita markkinoilla. Lisäksi tutkielman taustana käsitellään ilmastoriskien merkitystä 
sijoittajille sekä kestävän kehityksen jatkuvaa edistymistä. Nämä teemat sekä aiheeseen liittyvät 
tutkimustulokset luovat rungon tutkielmassa esitettyihin hypoteeseihin. 
 
Tutkielman tulokset tukevat pääosin esitettyjä hypoteeseja. Ilmastonmuutoshuolien 
lisääntyminen vaikuttaa negatiivisesti osaketuottoihin useimmilla alueilla. Lisäksi havaittiin, että 
Yhdysvalloissa, Suomessa ja Ruotsissa ilmastonmuutoshuolien negatiivinen vaikutus tuottoihin 
on voimakkain siirtymäriskeihin liittyvillä huolilla. Kun taas Euroopassa, Tanskassa ja Norjassa 
osaketuottoihin voimakkaimmin vaikuttavat ilmastonmuutoshuolet liittyvät fyysisiin riskeihin. 
Nämä tulokset vahvistavat, että ilmastonmuutoshuolilla ja osaketuotoilla on tunnistettava 
yhteys. Alueelliset erot taas viittaavat siihen, että ilmastonmuutoshuolien merkitys vaihtelee 
alueittain, mikä voidaan liittää alueiden eroihin kestävän kehityksen osalta. Tällä on tärkeitä 
vaikutuksia sijoittajien riskienhallintaan sekä tämä tarjoaa tietoa ilmastonmuutoshuolien 
merkityksestä päättäjille ja yrityksille. 
 
 
 
 
 
 
 
 
 
 
 
 
 

AVAINSANAT: ilmastonmuutos, ilmastoriski, vastuullinen sijoittaminen (SRI), vastuullisuus, 
ESG, osakkeiden tuotto, sijoittajien tarkkaavaisuus, riskien hallinta, Pariisin ilmastosopimus, 
Pohjoismaat 

  



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Contents 

1 Introduction 7 

1.1 Purpose of the study 11 

1.2 Structure of the study 15 

2 Dimensions of sustainable investing 16 

2.1 Shift towards sustainability 16 

2.2 Socially responsible investing 19 

2.3 The structure of climate risk 24 

2.4 ESG 27 

2.5 Sustainability in the Nordic countries 29 

3 Theoretical background 35 

3.1 The efficient market hypothesis 35 

3.2 The modern portfolio theory 37 

3.3 Behavioral finance perspective 39 

3.3.1 Market participants 41 

3.3.2 Theory of herd behavior 43 

4 Previous research 46 

4.1 Climate risk 46 

4.2 Public attention and sentiment 50 

4.3 The performance of green versus brown stocks 54 

5 Data and methodology 60 

5.1 Data description 60 

5.1.1 Dependent variables 62 

5.1.2 Media Climate Change Concern Index 63 

5.1.3 Control variables 66 

5.2 Methodology 69 

6 Empirical results 73 

6.1 Results for the main analysis 73 



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6.2 Comparison before and after the Paris Agreement 81 

6.3 Limitations and future research 90 

7 Conclusion 92 

References 95 

  



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Figures 
 
Figure 1. Sustainable investing in the US 1995-2020 (US SIF, 2020) 19 

Figure 2. Regional proportions of global sustainable investment assets 2022 (Global 

Sustainable Investment Alliance, 2022) 20 

Figure 3. Socially responsible investing strategies in Europe (Eurosif, 2018) 22 

Figure 4. Transition risk components (Giglio et al., 2021; Semieniuk et al., 2021; Venturini, 

2022) 25 

Figure 5. ESG ratings key issue framework (MSCI, 2024) 27 

Figure 6. GMB portfolio average return (Ardia et al., 2023) 57 

Figure 7. Media Climate Change Concerns Index (Ardia et al., 2023) 64 

 
 
Tables 
 
Table 1. Descriptive statistics 68 

Table 2. The OLS regression results with the aggregate MCCC index 74 

Table 3. The OLS regression results with the thematic MCCC indices. 77 

Table 4. The OLS regression results with the aggregate MCCC index before Paris 

Agreement 83 

Table 5. The OLS regression results with the aggregate MCCC index after Paris Agreement

 84 

Table 6. The OLS regression results with the thematic MCCC indices before Paris 

Agreement 86 

Table 7. The OLS regression results with the thematic MCCC indices after Paris 

Agreement 87 

 
 
 
 
 
  



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1 Introduction 

Climate change is one of the greatest global threats of our time. It is going to influence 

our life on the planet in many ways and some of the consequences can already be 

discovered all over the world. Climate change has caused problems such as rising sea 

levels, extreme weather disasters, water shortages, and the increased risk of floods and 

drought. In a constant effort to avoid these impacts, various measures have been taken 

to prevent them. The consequences of climate change and mitigation efforts can be 

detected to influence the financial market and especially the stock market.  

 

On the stock market, the influence of climate change is illustrated as climate risk. This 

represents all the risks investors face linked to the development of climate change. 

According to Giglio et al. (2021), climate risk consists of two main aspects, that are 

physical and transition risk. Transition risk includes risks related to the profitability of 

companies (Giglio et al., 2021). This consists of the risks of implementing new climate 

change inspired regulations or introducing a carbon tax, which can cause companies to 

have additional expenses or stranded assets. Physical risk includes the risks of the actual 

deterioration of company production assets due to climate change (Giglio et al., 2021). 

Physical risk can be further divided into acute and chronic physical risks (Venturini, 2022). 

An example of an acute physical risk to a company could be a climate disaster destroying 

a manufacturing facility.  

 

As the significance of climate change has emerged, there has been a clear shift towards 

sustainability. In general, this can be seen as policy changes, new regulations, and 

different environmental movements. These public efforts seem to concentrate on 

unifying the actions taken against climate change and encouraging all participants to 

reduce emissions (Hale, 2016). On a global level, the Paris Agreement 2015 has been one 

of the most important turning points in creating a common goal with efforts against 

climate change. This shift can be detected on the stock market as the development of 

guidelines and rating systems that help investors incorporate climate change into 

decision-making processes. This important participation in the sustainability of investors 



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is usually referred to as socially responsible investing (SRI). The main idea is that SRI is a 

strategy that incorporates environmental, social, and governance aspects in the 

selection process of securities (Eurosif, 2021). This has further resulted in the 

classification of stocks. “Green stocks” represent environmentally friendly and 

sustainable stocks. Whereas all other stocks are usually referred as “brown stocks”, 

which represent the opposite or just conventional stocks. The popularity of the SRI 

strategy has been constantly growing during recent years. According to a US SIF report, 

13 percent of total assets under professional management in the USA were using 

sustainable investing strategies at the end of the year 2021 (US SIF, 2023). This illustrates 

how important investors perceive sustainability in their investment decisions. Also, this 

shift has piqued the interest of researchers to gain more information about the effect of 

climate risk on the stock market which has caused a flood of literature in this area during 

recent years.  

 

The existence of climate risk is widely acknowledged and according to Krueger et al. 

(2020), investors have ranked climate risk as the fifth most important risk while 

considering investing. However, the dynamics behind the pricing of this risk remain 

partially unclear. There have been suggestions that climate risk would represent an 

anomaly, be an additional source of systematic risk, or a diversifiable risk related to a 

specific company (Venturini, 2022). The uncertainty starts with the pricing timing of 

climate risk. According to Venturini (2022), climate risk can be priced on an ex-post (after) 

or ex-ante (before) basis. It is more common that physical risks are priced on ex-post 

basis as the occurrence might be unexpected. As for an ex-ante basis pricing, fairly 

adverse evidence has been found in existing literature. Pástor et al. (2022) report finding 

a green stock premium, which has increased during the last decade. According to Faccini 

et al. (2023), the pricing of climate risk is more concentrated around the pricing of 

transition risks related to climate policy uncertainty. In different industries, the pricing 

seems to be at different levels, as the food stocks seem to underestimate the pricing of 

the risk (Hong et al., 2019), whereas in the energy sector, the prices of renewable energy 

stocks are positively impacted by climate risk (Dutta et al., 2023). On the other hand, 



9 

Bolton and Kacperczyk (2021) reported that higher carbon risk is positively compensated 

for. This is supported by the hedging assumptions (Faccini et al., 2023; Pástor et al., 2021). 

As green stocks are not as strongly exposed to climate risks, those stocks should provide 

a hedge to investors (Engle et al., 2020). Therefore, green stocks would produce a lower 

expected return when compared to brown stocks, which is rational as this difference 

would work as an expense for the gained insurance.  

 

The behavioral aspects of investors have caused the registered importance of climate 

risks being linked to the attention levels of investors. The attention level toward climate 

change can be increased by the realization of physical and transition risks or public 

conversation related to the topic. According to El Ouadghiri et al. (2021), an increase in 

public attention towards climate change has a positive effect on sustainability stock 

indices. This would mean that investors take climate risk increasingly into account when 

they are reminded of the existence of this risk. Also, Santi (2023) reports that increased 

attention toward climate change shifts investors’ selection toward more sustainable 

options. Both El Ouadghiri et al. (2021) and Santi (2023) believe that this reaction caused 

by the increased attention levels can be traced back to the disinvestment of conventional 

stocks.  

 

The pricing of climate risk and preference changes of investors have been detected to 

cause performance differences between green and brown stocks. According to Pástor et 

al. (2021), green stocks have positive ESG betas in an asset pricing equilibrium model. 

This indicates that major changes related to climate risk would have a positive influence 

on green stocks. However, the study shows that green stocks have negative CAPM alphas 

which implies a lower expected return due to the possibility of avoiding climate risk 

(Pástor et al., 2021). Still, during times of increased climate risk green stocks seem to 

outperform brown stocks. Also, Ardia et al. (2023) found that green stocks outperform 

brown stocks when there is an unexpected growth in climate change concerns. 

According to Choi et al. (2020) during abnormally warm weather high emission stocks 

underperformed lower emission stocks. On the contrary, Bauer et al. (2022) report a 



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reversal of this effect during the year 2022, when brown stocks seem to outperform 

green stocks. Also, El Ghoul et al. (2023) reported underperformance of socially 

responsible funds. However, these both could be related to the possible hedging against 

climate risk.  

 

The response of the stock market and investors to climate change can be traced back to 

traditional and behavioral finance theories. According to the efficient market hypothesis 

introduced by Fama (1970), stock prices should reflect accurately all existing information, 

which means that developments related to climate risk should be incorporated into the 

pricing. This would mean that climate risk should be incorporated into the fundamental 

price of stocks. Arguments for the investor response towards climate risk are supported 

by the modern portfolio theory, as there should be an effort to maximize the risk and 

return ratio. As climate change causes additional risk, investors should find ways to 

mitigate this risk, to improve the ratio. In research, it is reported that high ESG 

performance portfolios seem to have lower volatility (López Prol & Kim, 2022). On the 

other hand, the reaction could be traced back to a more realistic view of investor 

behavior. Raut et al. (2023) argue that the personal sense of responsibility plays a role in 

the decision processes and some investors have developed a preference to participate 

in the mitigation of climate change. In the group of retail investors, it is possible that 

personal values drive decisions, whereas with institutional investors reputation might be 

more important. Also, the growing trend of sustainable investing could be caused by 

herd behavior. According to Shi et al. (2024), investors tend to trade similar stocks, which 

is accelerated by growing trends. This has been detected in the Chinese stock market as 

herding towards carbon neutrality. In reality, the stock market reaction to climate risk 

could be caused by a combination of these reasons. 

 

The relationship between climate risk and the stock market seems to be affected by 

regional differences. Some countries only participate in the mandatory actions whereas 

others can be considered as sustainability leaders. The stage of sustainability in a certain 

country can depend on regional differences. According to Afzali et al. (2024), 



11 

corporations that operate in areas of higher climate change denial are proven to have 

lower environmental performance. Therefore, the attitudes of local communities can 

affect the progress of sustainable development. Also, Di Giuli and Kostovetsky (2014) 

report that companies headquartered in states characterized as Democratic are more 

socially responsible compared to companies in Republic states. When it comes to 

sustainable investing, it is mainly concentrated in the US and Europe. Especially, in 

Europe the conditions are favorable for sustainability, which constantly promotes the 

development of socially responsible investing. The EU has implemented different 

requirements that ensure transparency about sustainability efforts (Eurosif, 2021). 

Sustainability is even better in the Nordic countries, and they have been even referred 

to as the world sustainability leaders (Strand, 2024). The Nordics have been spotted at 

the top of multiple sustainability rankings. Also, it is well known that stakeholders put a 

lot of weight on the responsibility of companies which accelerates the transition toward 

a more sustainable society. As the relationship between climate risk and the stock 

market is partially connected to investor sentiment and attention, it can be assumed that 

regional differences can alter this relationship. 

 

 

1.1 Purpose of the study 

The purpose of this thesis is to examine the relationship between climate change 

concerns and stock returns in different regions. The level of climate change concerns is 

modeled by the Media Climate Change Concern (MCCC) index constructed by Ardia et 

al. (2023). The MCCC index models how the attention and sentiment towards climate 

change vary across time. This makes it possible to examine whether stock returns are 

influenced by the increasing climate change concern levels. The chosen regions 

(countries) for this evaluation are the US, Europe, and the Nordics, which include Finland, 

Sweden, Norway, and Denmark. The stock return of each region is illustrated with the 

return of a broad-base index that represents the whole stock market of the region.  

 



12 

As the stage of sustainability and attitudes toward climate change differ regionally, it 

could be assumed that also the magnitude of the impact of climate change concern on 

the stock returns could differ regionally. Therefore, this thesis aims to evaluate the 

possible differences between regions and extend the knowledge of the influence of 

climate change. According to Gong et al. (2023), there is evidence that climate risk 

premium has regional differences. As most of the published research is based on the US 

market. Therefore, this thesis attempts to present more information on the Nordics and 

Europe. This has an important contribution as those regions can be considered to be 

sustainability leaders (Strand, 2024). This could help determine whether the efforts 

aimed toward sustainability make a difference between regions. The chosen research 

design for this thesis concentrates on how climate change concerns affect the whole 

stock market in a specific region. Because of the chosen research design, the indices used 

in the thesis are conventional stock indices, and the formation of the chosen indices does 

not include strict sustainability metrics. 

 

The examination in this thesis is constructed of a main analysis and an additional analysis. 

The main analysis examines the effect of climate change concerns over the whole sample. 

The analysis should provide a view of how the general level of climate change concerns 

affect stock returns in different regions. Also, providing information on exactly what type 

of climate change concerns have the most significant effect on stock returns. In the 

additional analysis, the aim is to examine whether the effect of climate change concerns 

has changed over time. Therefore, there is an evaluation of different periods before and 

after the Paris Agreement. This should provide insight into whether the growing public 

interest in climate change has strengthened the relationship. In the following sections, 

the hypotheses of this thesis are presented with the results of supporting literature. The 

main hypotheses are the same for all the regions, which means that the direction of the 

impact is expected to be the same in all the regions. However, we expect the magnitude 

of the effect to alter depending on the region. 

 



13 

Firstly, in the examination of the impact of the aggregate MCCC index on the stock 

returns, it is expected that the climate change concern levels impact negatively the stock 

returns in all the regions. According to existing literature, when the climate change 

concern level increases it impacts the return of green stocks positively (Ardia et al., 2023; 

El Ouadghiri et al., 2021; Pástor et al., 2021; Santi, 2023). As our sample includes 

conventional stock indices, the effect is expected to be negative in all regions. The 

increase in climate change concerns causes the disinvestment of conventional stocks as 

they contradict investor preference (El Ouadghiri et al., 2021; Santi, 2023). According to 

Ardia et al. (2023), climate change concerns seem to have a stronger impact on brown 

stocks as investors seemingly discipline brown stocks. However, it is expected that the 

sustainability of the region influences the effect. Therefore, the negative impact is 

expected to be least pronounced in the Nordic countries, which can be labeled as 

sustainability leaders (SDSN, 2023; Strand, 2024). Based on this literature, we assume 

the following hypothesis on the relationship between stock return and climate change 

concerns. 

 

H1:  The increase in climate change concern levels has a negative impact on stock return. 

H1a: The negative impact is least pronounced in the Nordics.  

 

In the examination of the impact of the thematic MCCC indices on the stock returns, it 

is expected that the increase in concerns with transition risk related themes has the 

largest negative impact on the stock returns. This assumption is based on the existing 

literature highlighting the importance of transition risks to investors. This view of 

investors has been confirmed by a survey conducted by Stroebel and Wurgler 

(2021).  The results of the survey reported that investors believe transition risks to be 

the most important climate risk over the next five years. According to Faccini et al. (2023), 

while researching the pricing of climate risk, only evidence of the pricing of transition 

risk was found. Also, Ardia et al. (2023) conducted a similar evaluation with the MCCC 

index and resulted in the conclusion that transition risk related concerns have the biggest 

negative impact. In all the regions, it is expected that the transition risk related concerns 



14 

are most relevant. Based on this argumentation, the following hypothesis number two 

is formed. 

 

H2: The increase in climate change concerns with transition risk related theme has the 

most negative impact on stock return. 

 

In the additional analysis of the effect of climate change concerns, during periods before 

and after the Paris Agreement, it is expected that the effect of concerns on the stock 

returns has strengthened after 2015. This means that if the climate change concern level 

increases, the stock returns are more negatively impacted after the Paris Agreement. 

This assumption is based on the growing trend of investors including climate risks in their 

asset selection process. According to Krueger et al. (2020), the importance of climate 

risk has increased during the recent years, and it has been ranked as the fifth most 

important risk. Also, Bolton and Kacperczyk (2021) reported that carbon risk premium 

has increased after the Paris Agreement. Meaning that the importance of climate risks 

has increased. In general, the existing literature indicates that when the attention level 

toward climate change increases, it should increase the importance of climate risk 

perceived by investors (El Ouadghiri et al., 2021; Santi, 2023). Therefore, it is assumed 

that the growing attention toward climate change and the implemented mitigation 

efforts are constantly strengthening the effect of climate change concerns on stock 

returns. However, this strengthening is expected to be strongest in the USA, as other 

regions are generally more sustainable (Strand, 2024). Based on this evidence, the third 

hypothesis of this thesis is formed in the following manner. 

 

H3: The negative effect of climate change concerns has strengthened after the Paris 

Agreement. 

H3a: The negative effect has strengthened most clearly in the USA. 

 

The objective of this thesis is to provide support to the three hypotheses by conducting 

an empirical analysis. In addition, to confirming the hypotheses for each region, we 



15 

expect to be able to provide evidence that the magnitude of the effect varies among 

different regions. Possibly indicating that the effect of climate change concerns is 

stronger in other regions, possibly depending on the sustainability of the region. 

Therefore, the results are expected to contribute regional information on how the 

increase of climate change concern levels affects the stock return. In addition, 

elaborating which type of concerns are the most significant for the stock returns. From 

the examination of periods before and after the Paris Agreement, the aim is to address 

how the relationship has changed over time. The contribution of these results would be 

to help investors in risk management and provide useful information for policymakers. 

More specifically, the results could contribute to risk management, as to whether some 

of the climate risk could be reduced with geographic diversification. 

 

 

1.2 Structure of the study  

The structure of the thesis is presented in this chapter. At the start of the thesis, there is 

an introduction, which provides a brief overview of the topic. After that, there is a 

chapter regarding the dimensions of sustainable investing. It focuses on the 

development of sustainability and socially responsible investing in general. Also, it 

provides an overview of the climate risk factors and introduces the measurement used 

for sustainability. The third chapter concentrates on the theoretical background, by 

presenting the relevant financial theories for the thesis. In chapter four, the existing 

research related to the topic is presented. In chapters four and five the data and 

methodology used in the thesis will be addressed and further, the empirical results are 

presented. In the final chapter, there is a discussion of the findings and conclusions. 



16 

2 Dimensions of sustainable investing   

This chapter focuses on the different aspects of sustainability related to investing. It 

should provide a brief overview of the historical developments around sustainability. 

After this, the focus is aimed towards socially responsible investing and how it is 

implemented on the stock market. In addition, we will cover the basic structures of 

climate risk and ESG. This will provide an understanding of the metrics of how risks and 

sustainable performance are defined. Lastly, the characteristics of sustainability in the 

Nordic countries are discussed to gain a perspective on regional aspects. 

 

 

2.1 Shift towards sustainability  

During the recent years, there has been a noticeable shift towards sustainability in our 

society. This can be detected from the growing news media coverage, policy changes, 

and different climate movements (e.g. Earth Hour) that have been able to draw more 

attention to these climate related issues. This has helped all the participants to align 

efforts towards a common goal, therefore making the influence of the actions taken 

much more effective. All these developments have helped the transition towards a more 

sustainable investing environment.  

 

One of the most significant turning points of sustainability can be said to be the Paris 

Agreement. In December 2015, the United Nations updated the previous agreement on 

climate change to create the Paris Agreement. In this agreement, a limit of global 

warming was decided to be 2 °C, and all the participants were required to take action to 

succeed in this target. According to Hale (2016), the goal was to support the progress of 

creating conditions that would increasingly encourage all participants to reduce 

emissions. As a consequence of the Paris Agreement, the objective related to 

sustainability has been unified among many countries. Essentially, all the countries were 

coming together to try to mitigate climate change with their own different policy shifts 

aimed toward the common target. 



17 

 

According to Peake and Ekins (2017), this development included behavioral and 

technological aspects. General behavioral changes could help incorporate climate 

aspects into the decision-making processes of corporate executives and investors. The 

significant role of investors is highlighted because a lot of funding is needed to make this 

transition to a sustainable economy possible. Especially, the technological developments 

during the transfer towards renewable energy have required both public and private 

funding (Peake & Ekins, 2017). Therefore, favorable circumstances needed to be created 

with policy shifts to ensure the capital flow and motivation toward this transition.  

 

Another noticeable unification of incorporating climate change into decision-making 

processes has been the development of different guidelines for sustainable investing 

such as Principles of Responsible Investing (PRI) and parameters to measure the 

sustainability of investments such as the environmental, social, and governance (ESG) 

factors. The global investor association Principles of Responsible Investing (PRI) is built 

on six ESG-related principles. The PRI began to grow in 2006 and currently over 4,000 

investment managers have signed the principles. According to Majoch et al. (2017), the 

association does not directly have mandatory requirements for the implementation of 

these principles and therefore, leaving execution options to the investors. Fundamentally, 

the association wants to support and encourage investors to make more sustainable 

ownership and investment choices.  

 

From the point of view of companies, environmental policies play a considerable role in 

motivating the transition towards more sustainable operations. Regulations are often 

aimed toward emission levels because for a long-time carbon dioxide (𝐶𝑂ଶ) emissions 

have been considered to be the primary source of human accelerated climate change 

(Nordhaus, 1993). Companies are responsible for emissions on three levels set by the 

standards of the Greenhouse Gas Protocol (2004). Firstly, Scope 1 illustrates the 

emissions created by the sources owned by the company as the direct emissions. 

Secondly, the emissions created by the consumed electricity are illustrated as Scope 2 



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indirect emissions. Lastly, Scope 3 represents indirect emissions caused by other 

activities of the company, for example outsourcing.  

 

These firm-level emissions are influenced by the regulations and policies implemented 

in the region. Ben-David et al. (2021) discovered that companies headquartered in 

countries with strict regulations are proven to move emission-creating activities to 

countries with more loose environmental policies. However, these companies are still 

reported to have lower pollution levels globally (Ben-David et al., 2021). Therefore, 

emission regulations slowly incentivize companies toward more sustainable operations. 

In addition, the reporting requirements of companies have been updated to support 

sustainable development. During the start of 2023, the Corporate Sustainability 

Reporting Directive (CSRD) entered into effect for EU-companies (European Commission, 

2024). As companies are forced to report their actions, it makes them more accountable. 

Furthermore, the necessary levels of emissions and the levels of environmental 

friendliness are discovered, and it provides investors information about which 

investments are sustainable.  

 

The development towards sustainability can be in different stages in different countries 

and even in different areas in the country. This is partly due to cultural differences, 

different geographical locations, political leanings, and the stage of social capital and 

trust which all have an impact on the operating environment of the company. For 

example, Di Giuli and Kostovetsky (2014) reported that companies headquartered in 

states that can be characterized as Democratic are more socially responsible compared 

to companies in Republic states.  In addition to this, the local attitude towards climate 

change plays a role. According to Afzali et al. (2024), companies that operate in higher 

climate change denial US counties are proven to have lower environmental performance 

scores. These attitudes in local communities create obstacles to sustainable 

development and increase the risk of larger environmental costs for society (Afzali et al., 

2024). This emphasizes the importance that every individual participates in the shift 

towards sustainability, not only large entities. 



19 

 

2.2 Socially responsible investing 

As a response to these global challenges, concepts such as sustainable development and 

corporate social responsibility have evolved. As a way for investors to participate in this 

effort directly by themselves, socially responsible investing has emerged. Some argue 

that the need for socially responsible investing was accelerated by the global financial 

crisis of 2008, as stakeholders started to pay more attention to responsibility and 

accountability in the market participants (Scholtens & Sievänen, 2013).  Socially 

responsible investing (SRI) is a strategy defined as incorporating environmental, social, 

and corporate governance aspects in the selection process of securities and investor 

advocacy (Eurosif, 2021; US SIF, 2023). It enables investors to gain long-term returns and 

simultaneously strengthen the well-being of society by influencing corporate behavior 

(Eurosif, 2021).  US SIF (2023) explains that different types of motivations have been the 

reason for the growth of sustainable investing. Motivation varies from personal values 

and ethical goals to demands of clients and mission to achieve superior financial 

performance (US SIF, 2023).  
 

 

Figure 1. Sustainable investing in the US 1995-2020 (US SIF, 2020) 

 



20 

During the last decade, socially responsible investing has grown substantially worldwide.  

According to a review published by the Global Sustainable Investment Alliance (2022) 

approximately $30.3 trillion is globally in assets invested by applying the ESG criteria in 

the investment asset selection process. In Figure 1 it can be seen that the US markets in 

socially responsible investing started to grow most rapidly after 2012 and the trend has 

continued ever since (US SIF, 2020). As for non-US markets, there has been a 20% 

increase in sustainable investment since 2020 (Global Sustainable Investment Alliance, 

2022). The biggest class of SRI is equities, representing almost a 46,5% portion (Eurosif, 

2018). Most of the socially responsible investments are undertaken by institutional 

investors (Eurosif, 2018). However, the importance of retail investors in the continuity of 

SRI has been widely recognized. Both of these are connected as retail investors typically 

participate in investing through SRI funds (Scholtens & Sievänen, 2013). 

 

 

Figure 2. Regional proportions of global sustainable investment assets 2022 (Global 
Sustainable Investment Alliance, 2022) 

 

Among different regions, most of the global sustainable investing is largely concentrated 

in Europe and the US, as seen in Figure 2. The proportion of Europe has increased 

significantly during the last two years. According to the review of the Global Sustainable 



21 

Investment Alliance, after the UN Principles for Responsible Investment and the 

Sustainable Development Goals, Europe has been considered to be a leader in many 

aspects of social responsibility and continued to show an example by implementing new 

actions to improve the current state of the world. 

 

The conditions in Europe are favorable for sustainability which promotes the 

development of socially responsible investing. One of the crucial aspects in creating 

these conditions is the legislation and regulations that support the transition towards a 

more socially responsible direction. In the European region, the EU is mainly responsible 

for these, and it has been a great advocate for social responsibility. The EU has 

implemented requirements that ensure transparency about sustainability in 

corporations and investment products offered by financial institutions (Eurosif, 2021). 

One of the recent actions taken has been the framework for financial advisers as in the 

Sustainable Finance Disclosure Regulation (SFDR). The framework ensures that financial 

advisers and market participants communicate sustainability information accurately to 

investors (European Commission, 2024). With these actions, the risk of greenwashing is 

mitigated, and investors can be more aware of the state of sustainability of their 

investments. In addition, one strength in sustainable development is the general 

awareness of environmental challenges in Europe. In a survey conducted by European 

Investment Bank (2019), it was presented that 78% of Europeans are concerned about 

climate change whereas in the USA only 63% of the respondent citizens were concerned. 

This creates an increased social and cultural pressure to operate and invest in a socially 

responsible manner in the European region. 

 



22 

 

Figure 3. Socially responsible investing strategies in Europe (Eurosif, 2018) 

 

Socially responsible investing is usually implemented with different SRI investment 

strategies. In Figure 3, the graph presents the popularity differences between SRI 

strategies during two years in Europe and the compound annual growth rates (CAGR) for 

each one (Eurosif, 2018). Exclusions remain as the dominant strategy. However, in the 

growth figures, it can be seen that investors increasingly want to enhance sustainability 

through their own engagement and therefore increasing the popularity of strategy 

engagement and voting (Eurosif, 2018). Different strategies enable the investors to 

choose the best way for them to invest socially responsibly. These strategies can be used 

independently or in a combination of multiple strategies.  

 

 The main idea of the strategy best-in-class is that it takes into consideration how 

companies perform in ESG in a particular industry. Investors choose the industrial sector 

they want to invest in and pick the companies with the best ESG scores (Eurosif, 2018). 

This strategy sets the ESG performance in proportion and acknowledges the possible 

efforts with ESG. Naturally, financial evaluation is implemented for all investment 

equities. The benefit of this strategy is to consider the impact of the industry on what 

level of ESG performance is even possible for the companies. For example, software and 

manufacturing companies have different premises to try to minimize emissions. 



23 

Sustainability themed investing strategy focuses on selecting assets that are related to a 

specific area of sustainability. These themes can be for example water management, 

sustainable transport, renewable energy, and energy efficiency. Most popular among 

investors have been climate change and water-themed assets (Eurosif, 2018). The 

strategy of norms-based screening is based on investors selecting assets that are in line 

with the preferred international standards and norms. These can focus on aspects such 

as labor standards, human rights, and environmental protection. There has been a 

significant decrease in the popularity of norm-based screening as seen in Figure 3. 

However, the most popular base for the norms has been the UN Global Compact (Eurosif, 

2018).  

 

The most popular SRI investing strategy is exclusions with engagement and voting being 

the second most popular. Exclusion is the oldest socially responsible investing strategy 

(Eurosif, 2018). The aim is to consistently exclude companies and industries that are not 

socially responsible. Common areas to exclude are weapons, tobacco, and animal testing. 

However, there is a contradiction about whether the exclusion strategy can be labeled 

as an SRI strategy when used alone. According to Eurosif (2018) disinvesting in these 

harmful industries cannot be considered to have a strong enough impact and therefore, 

it should be combined with an attempt to impact through engagement and voting. As a 

strategy engagement and voting concentrate around the active management by 

investors. Investors’ objective is to constantly influence and monitor the companies they 

invest in. Ensure that the company is constantly working towards more sustainable 

business operations. 

 

Socially responsible investing is not that well-defined as an investing strategy and there 

are many ways to perform it. However, at the center of it is incorporating ESG aspects in 

the selection process of assets. Still, Sandberg et al. (2009) have raised questions about 

the problems in the heterogeneity of socially responsible investment. Differences can be 

found in definitions, terminology, strategy, and practice. Standardization would be 

desirable to unify the objectives of investors and further strengthen the impact. However, 



24 

it can be said that socially responsible investing is a multidimensional way of investing 

and in the end, the meaningful implementation of it is the responsibility of the investors. 

 

 

2.3 The structure of climate risk 

Driving these previously presented movements is the acknowledgment of the risks 

related to climate change. In climate finance literature, it has been presented that 

climate change creates a climate risk in the financial market which affects the return on 

investment (Faccini et al., 2023; Venturini, 2022). This is important to investors whose 

main goal is to be constantly trying to maximize profits. According to a survey conducted 

by Krueger et al. (2020), the general perception of investors is that climate risk influences 

portfolio risk and return. Climate risk can cause additional expenses for companies and 

create price alterations in different assets. Directly to companies’ own processes, the 

climate risk causes additional expenses such as growth in financing and equity costs 

(Chen & Gao, 2012). As a consequence of these effects, the investors take climate risk 

increasingly into consideration in their investment processes. The more you are exposed 

to risk factors the bigger impact it has on financial performance. As for a more detailed 

understanding of climate risk, it can be divided into two categories that are physical and 

transition risk. 

 

Physical risk illustrates the risks of immediate deterioration of company production 

assets due to climate change (Giglio et al., 2021). The subject of the physical risk can be 

for example the properties and facilities owned by the company or the deterioration of 

real-estate values. For instance, this risk can materialize as a climate disaster that 

destroys the company’s assets and causes damage to the business. Furthermore, 

physical risk can be categorized into two types, namely acute and chronic physical risks 

(Venturini, 2022). An example of an acute physical risk can be a wildfire caused by 

extreme drought and abnormally warm weather. Acute risks such as climate disasters 

and sudden extreme weather conditions can be hard to predict and prepare for. Whereas 

chronic physical risks can be predicted because they usually materialize gradually. Such 



25 

as rising sea levels create a progressive threat, that can be calculated and therefore 

forecasted. In addition, the company’s exposure and vulnerability affect the level of 

physical risk (Venturini, 2022). Exposure illustrates the locational distribution of entities 

and assets that could be exposed to climate hazards. Whereas vulnerability focuses on 

the company's ability to adapt to different materializing hazards. 

 

Transition risk has a multidimensional effect on company profitability and processes. This 

risk is related to decisions about the economy to become more sustainable, which can 

cause other companies to have competitive advantages and others to have stranded 

assets (Giglio et al., 2021). An example of this type of risk could be the introduction of a 

carbon tax by the government. This can cause industries that use fossil fuels to have 

growing expenses and suffer losses. Transition risk does not always have a clear and 

specific effect, as the actions taken to enhance the shift towards a more low-carbon 

economy have several different consequences through multiple different channels.   

 

 

Figure 4. Transition risk components (Giglio et al., 2021; Semieniuk et al., 2021; Venturini, 
2022) 

 

As for a more detailed breakdown of transition risk, climate finance literature suggests 

that it contains policy risk, technology risk, and preference change components as seen 

in Figure 4 (Giglio et al., 2021; Semieniuk et al., 2021; Venturini, 2022). First, two of the 

components can be said to be intertwined. The policy component includes public actions 

taken to mitigate climate change. For example, introducing new sustainability standards 



26 

and regulations. These actions usually create incentives to accelerate the development 

of new sustainable technologies for companies. New innovations can save costs and 

accelerate the incorporation of low-carbon technologies (Semieniuk et al., 2021). On the 

other hand, investments and commitments companies need to put into these new 

developments can create additional expenses. The last aspect of transition risk is the 

preference change of investors and consumers (Venturini, 2022). This illustrates the risk 

of a strengthened desire to invest capital in climate friendly companies and consume 

products created by green companies. This preference is motivated by investors' and 

consumers’ own sentiments and attention toward climate change. However, this can 

create an opportunity for environmentally friendly companies to benefit from, and 

create a competitive advantage compared to conventional companies (Semieniuk et al., 

2021). 

 

In the existing literature, Giglio et al. (2021) state that there is a clear connection 

between transition and physical risks. This correlation between the two can be noticed 

without the risk materializing simultaneously. The growth in the frequency of climate 

disasters and other appearances of physical risks causes a requirement for new 

mitigation actions which increases transition risks. Therefore, a materialization of 

physical risks increases the probability of transition risk. On the contrary, when 

additional regulations are appointed, it can help the mitigation of climate change and 

possibly reduce the appearance of physical risk. 

 

To understand better how climate risk is priced on the financial market, investors need 

to have a clear view of the nature of the risk. There has been a lot of research debating 

whether physical or transition risks are more imminent for investors. It has been 

demonstrated that investors believe that especially transition risks are constantly 

materializing and therefore priced in the financial markets (Krueger et al., 2020). 

Stroebel and Wurgler (2021) find similar results, that investors perceive transition risks, 

especially regulatory risks, to be the most significant risk for businesses. Whereas 



27 

physical risk is commonly believed to be the most important risk within the next 30 years 

(Stroebel & Wurgler, 2021). 

 

2.4 ESG  

As mentioned before, investors are constantly participating in the actions to mitigate 

climate change and there has been a growing trend to direct investments toward more 

sustainable options. For, investors to easily recognize and evaluate these sustainable 

investment targets, the ESG rating system was created. The ESG stands for environmental, 

social, and governance. Similarly, as companies have received credit ratings illustrating 

their ability to meet debt obligations, the ESG rating describes the nature of the 

company’s environmental impact, social responsibility, and corporate governance. 

Ratings give a vast amount of information to the investors in a condensed form which 

simplifies the assessment of the potential risks linked to the investments. Currently, the 

leading ESG rating providers can be said to be MSCI and Sustainalytics. These companies 

provide ESG ratings for companies worldwide. 

 

 

Figure 5. ESG ratings key issue framework (MSCI, 2024) 

 



28 

Figure 5 presents an example of general key issues used in constructing the ESG rating 

for a company (MSCI, 2024). MSCI divides the different pillars into differently themed 

subcategories.  Among all the rating agencies the environmental aspect concentrates on 

the climate effects of the company. For example, measuring emission levels or the 

company's carbon footprint. Social responsibility focuses on how the company affects 

the surrounding society such as equality, diversity, and fair working conditions. The last 

aspect concentrates on the governance practices of the company, which evaluates 

corruption, executive pay, and authority distribution. Even though all three aspects of 

ESG represent important themes that all corporations should consider in their actions. 

Still, the environmental aspect is playing the leading role and making the environmental 

impact of the company often the most highlighted rating aspect. According to research 

conducted by Krueger et al. (2020), specifically climate-related risks are included in the 

top concerns of investors. 

 

The agencies that provide ESG ratings play a crucial role in the stock market because 

investors are increasingly relying on their information and making strategic decisions 

based on the ratings (Chatterji et al., 2016). Due to this increasing weight of ratings in 

the investment decision processes, there have been comparisons between different 

agencies. Berg et al. (2022) found significant differences in ESG ratings between different 

rating providers. In the article, the primary creator of divergence was traced to be the 

measurement differences, including definition variation and alternations in the analyzed 

data. Also, the ESG ratings are closely linked to the extent of disclosure. Based on this 

Christensen et al. (2022) confirmed that disagreement among ESG ratings increases 

when ESG disclosure expands. As the amount of information grows, there is more 

information to disagree over. Christensen et al. (2022) argue that in the absence of 

information, rating agencies are more likely to rely on similar rules of thumb and are 

more likely to agree. However, the researchers believe that over time there will be more 

standardized metrics, and consensus will be found (Christensen et al., 2022). 

 



29 

As the importance of ESG ratings has grown, it is natural that it has implications on 

company value. Fatemi et al. (2018) argue that ESG strengths would increase the 

company's value. Whereas deficiencies in ESG would decrease the value. In addition, 

Fatemi et al. (2018) report that announcements related to ESG would have a direct effect 

on the company value. However, frequent announcing of ESG strengths would cause a 

much minor increase in value and therefore weaken the positive influence on the 

company value. In the study, the authors explain this to be a consequence of the public 

perception of the company trying to justify its actions or polish its public appearance. 

 

In addition, there have been implications of ESG ratings playing a role in stock price 

reactions. Gao et al. (2022) state that ESG mitigates the risk of stock price crashes. 

Therefore, focusing on the ESG performance could stabilize the stock price 

developments. In the paper, the authors state that the mitigation effect is reached by 

drawing the attention of green investors (Gao et al., 2022). In other words, this highlights 

the importance of company ESG performance and the investors' preference towards it. 

However, investing in high ESG performance stocks is much harder in the presence of 

ESG rating disagreement. According to Billio et al. (2021), the disagreement between 

rating agencies mitigates the effects that ESG investors have on the return of stocks. 

Therefore, not all the possible effects of ESG performance can be currently detected in 

the financial performance of stocks. Still, considering the benefits, that good ESG ratings 

can create, all companies have the incentive to pay attention to their performance in this 

area. 

 

 

2.5 Sustainability in the Nordic countries 

Environment, social, and governance aspects have been noticed to be at different levels 

in different regions. Some countries are the sustainability leaders whereas others 

participate only in mandatory actions. Also, other countries emphasize different aspects 

of sustainability more. According to Kvasničková Stanislavská et al. (2023), the 

sustainability reports of developed countries have focused more on topics such as 



30 

“sustainable production” and “supply chain emissions” whereas developing countries 

pay more attention to themes such as “education” and “human rights”. These differences 

could be caused by cultural differences, the pressure created by stakeholders, the 

attitude of the government, or the financial opportunities. As a solution, the constantly 

evolving sustainability reporting provides information to estimate the level of 

sustainability efforts in different regions.  

 

It has been stated that the Nordic countries are the world sustainability leaders (Strand, 

2024). In the sustainable development report (SDSN, 2023), the Nordics were all ranked 

in the top 5 countries in Europe based on the SDG index score. In addition to this, the 

Nordics have been spotted at the top of multiple other sustainability rankings (Strand, 

2024). In the Green Growth Index (GGGI, 2019), the Nordics were ranked the highest 

globally. All of this indicates that in the Nordic countries, stakeholders put a lot of weight 

on the responsibility of companies which accelerates the transition. Strand (2024) 

explains that the sustainability success of the Nordics is ensured by the close cooperation 

of stakeholders and the general commitment to sustainability that has been 

incorporated into the Nordic socio-economic structures. Also, the high tax levels in the 

Nordics cause corporations and society to work closely together which can harmonize 

sustainability efforts (Strand, 2024).  

 

The public administration plays a significant role in the transition towards a green 

economy in the Nordic countries. Therefore, the policies must be aligned to support 

technology development and innovation in a sustainable direction. Khan et al. (2021) 

study the policy documents in the Nordics and find aspects that support green growth 

and the transformative green economy approaches. In addition, it is observed that 

during this transformation the importance of human well-being is recognized in the 

Nordics (Khan et al., 2021). With these actions, the state actors are able to actively 

influence the direction of the economy. This can work especially in the Nordics as they 

have been known to have interventionist state institutions. As for successfully 

transitioning to a green economy, it requires stakeholders, investors, and corporations 



31 

to work towards a common goal. This should be possible as it is a general perception 

that a green economy should increase competitiveness and reinforce growth as the 

demand for green services and products intensifies (Khan et al., 2021). However, there 

is still debate on whether it is effective to aim the development towards a generally 

green economy or whether the support should be aimed towards a specific target such 

as a low-carbon economy (Khan et al., 2021). 

 

One of the current accelerators of Nordic sustainability has been the incorporation of 

new sustainability reporting standards. The Corporate Sustainability Reporting Directive 

(CSRD) became effective at the beginning of 2023 (European Commission, 2019). The 

directive will apply for the 2024 financial year and the first reports should be published 

in 2025. The standard gives corporations specific rules about what environmental and 

social information needs to be reported (European Commission, 2019). These rules make 

sustainability reporting more relevant and unified. As a result, it guarantees that 

investors and stakeholders are extensively informed about the impact that the company 

has on the environment and other sustainability issues. This provides companies with 

better opportunities to communicate their own sustainability efforts. Also, this 

standardization can possibly mitigate the risk of greenwashing as all participants have 

better access to information on the true state of the company's sustainability. Therefore, 

this standard is beneficial to all parties involved and it can incentivize them to participate 

even more in the sustainability efforts.  

 

Investor participation in sustainability in the Nordics has increased through the 

popularity of socially responsible investing. In general, socially responsible investing can 

be carried out with screening and shareholder engagement. The Nordic countries do 

have slightly different starting points in socially responsible investing, as Finland is the 

newest in this field. In addition, different drivers have shaped the development of SRI in 

the Nordic countries. The drivers are important to recognize, as most of the Nordic 

countries do not have an explicit framework for SRI. According to Scholtens and Sievänen 

(2013), drivers for SRI are still similar in all four countries. These can be listed as the role 



32 

of institutional investors, national pension funds, religious movements, and the 

popularity of different types of investment strategies. Also, the researchers noticed that 

the pension industry has a clear impact. More specifically, for Norway, SRI development 

has been strongly driven by the Norwegian Petroleum Fund and other pension funds 

that are regulated (Scholtens & Sievänen, 2013). As for Finland and Sweden, religious 

institutions have been key actors (Scholtens & Sievänen, 2013). A closer inspection is 

taken on the SRI in Finland, Sweden, Denmark, and Norway. 

 

 The four countries are mainly viewed as being similar in many aspects, but in the history 

of sustainability, there are still some different features among the countries. Finland is 

often introduced as a relative newcomer when compared to other Nordic countries 

(Scholtens & Sievänen, 2013). Especially, in socially responsible investing, the first 

activity can be spotted in 1999. However, Finland is still one of the leading countries in 

sustainability. According to a market settlement carried out by Finsif (2022), investors in 

Finland choose sustainable options based on values, sustainable development, and 

better risk management. The most important focus in the future was named to be the 

diversity of nature (Finsif, 2022). For sustainable investing, the future challenge can be 

said to be the increasing regulation and implementation of the regulation, as growing 

competence in the area is needed. In Finland, most popularly investors prefer to 

implement sustainable investing with ESG- integration and exclusion. 

 

In Sweden, the development was very early in the field of socially responsible investing 

as the first ethical funds can be traced to the 1960s (Scholtens & Sievänen, 2013). 

Therefore, it can be called one of the pioneers of SRI. According to Eurosif (2018), the 

SRI market in Sweden is currently very advanced, and many of the large institutional 

investors have a framework for sustainable investment. In Sweden, it is common for 

institutional investors to use many SRI strategies simultaneously. The most commonly 

implemented SRI strategy is engagement and voting (Eurosif, 2018). Many platforms 

have been founded to ensure green financial solutions and constant developments in 

sustainable finance. For example, the Stockholm Sustainable Finance Centre (SSFC) and 



33 

Stockholm Green Digital Finance (SGDF). Sustainable investment practices still lack of 

specific legal framework. However, in Sweden, this has been compensated by Swesif’s 

assessments of the sustainability of investment funds (Eurosif, 2018). This kind of 

declaration of sustainability has accelerated the sustainability efforts of funds.  

 

Historically the Norwegian financial industry has been considered to be leaders for SRI 

and it has influenced the development of SRI globally (Eurosif, 2018). This has been made 

possible by the large size of the Norwegian financial sector. In Norway, the first activity 

of socially responsible investing was seen in the late 1980s (Scholtens & Sievänen, 2013). 

With a strong foundation of SRI, many large investors have persistent sustainability 

policies and behave as SRI issue advocates. Sustainable investment is strongly affected 

by the Norwegian Government Pension Fund Global which is managed based on the 

government guidelines (Eurosif, 2018). For the Norwegian government, climate change 

has remained one of the important focus areas. Therefore, the government provide an 

example of socially responsible investment decisions. Also, Norway has its own SIF 

association, which aims to increase the knowledge of incorporating ESG into investment 

decisions. In Norway, the EU is the main source of regulatory changes that have been 

currently aimed towards improved disclosure and transition to a low carbon economy 

(Eurosif, 2018). 

 

Despite the smaller size of Denmark, their financial markets are well developed. As for 

socially responsible investing in Denmark, it can be traced back to the 1990s when the 

first ethical funds were spotted (Scholtens & Sievänen, 2013). The development has 

been influenced by the investors' demands for the formalization of SRI. In 2018 the 

Danish Government published standardized guidelines for responsible investment. The 

guidelines were based on the OECD’s Responsible Business Conduct for Institutional 

Investors and OECD’s Guidelines for Multinational Enterprises (Eurosif, 2018). Curiously, 

based on a survey 39 % of the investors already have procedures in place that match 

with the guidelines.  As for, socially responsible investing the exclusion strategy remains 

distinctively the most popular strategy with the norms-based screening strategy coming 



34 

second (Eurosif, 2018). The incorporation of ESG themes in investment decisions has 

been most advanced among listed equities. According to Eurosif (2018), 41% of Danish 

investors informed of assessing their portfolio's carbon footprint and 44% took into 

consideration particularly environmental issues. Also, for the investment community, 39 % 

of investment company respondents have more than one resource dedicated to 

responsible investing and ESG information.  



35 

3 Theoretical background 

This part of the thesis concentrates on the structures and characteristics of the stock 

market. The aim is to help understand how different changes and risk factors might be 

able to influence the price evolution of different types of stocks. This is illustrated by 

presenting the most relevant financial theories related to the topic. Theories related to 

the motivation for sustainable investing can be found both in traditional finance and 

behavioral finance. The reasons linked to traditional finance theories are mainly focused 

on the relationship between risk and return whereas behavioral finance concentrates on 

the personal characteristics of investors. Different characteristics can make investors 

experience non-financial utility from sustainable investments or make them more prone 

to herd behavior which further increases the trend of SRI.  

 

 

3.1 The efficient market hypothesis 

The efficient market hypothesis was first introduced by Fama (1970), who presented 

foundations for how stock prices are constructed on the stock market. The concept of 

efficient markets consists of the idea that market prices reflect all the existing 

information accurately and investors cannot create excess return by analyzing the 

information. Fama (1970) presents that the efficiency of the markets can be described 

by three different levels, based on how well the market prices reflect information. This 

theory gives guidelines for understanding the behavior of the stock market and how the 

stock prices develop after new information is discovered. 

 

The first level of market efficiency introduced by Fama (1970) is the weak form. This 

efficiency level requires that the current stock price includes all the historical information. 

This includes information about previous developments of the stock price, previous 

stock prices, trading volumes, and profits (Fama, 1970). This means that by analyzing the 

historical data of the stock, the investors should not be able to create excess return, as 

the price should already include all this information. The second level is rated as a semi-



36 

strongly efficient market. This indicates that the stock price should include all the other 

easily available information, and the accurate pricing of this information should be 

immediate (Fama, 1970). For instance, when the corporate executives announce recent 

business developments or annual reports. The last level introduced by Fama (1970) is 

strongly efficient markets which indicates that all insider information is reflected in stock 

prices. This means that no market participants should have a certain advantage over any 

of the meaningful information. When all these levels are fulfilled the stock price should 

reflect the company’s accurate value. 

 

According to Fama (1970), for the efficient market theory to be completely accurate, the 

following market conditions are needed. The first assumption about the conditions is 

being able to trade equities without transaction costs and therefore making the markets 

frictionless. Secondly, all market participants should be able to access all available 

information without additional expenses. Finally, every market participant is constantly 

rational and agrees on how the most recent available information affects the existing 

stock price, and toward which direction the stock price is going to develop in the 

future.  Still, it is stated, that even without all of these conditions being fulfilled in reality, 

the stock markets can act efficiently (Fama, 1970). Therefore, the theory can be applied 

in the evaluation of how different informational developments influence stock returns. 

 

As mentioned earlier, it has been acknowledged that the rationality of investors has a 

part in creating market efficiency. However, there are still investors who do not trade 

rationally as stated in the previous chapter, and their trading transactions are considered 

to be more random (Degutis & Novickyte, 2014). Based on this notion, Degutis and 

Novickyte (2014) divide investors into two categories. Noise traders who do not base 

their trading decisions on information. And proficient investors who evaluate their 

investment decisions precisely. Even though these different investors participate in the 

markets, the effects seem to be reversed. Proficient investors can benefit from the 

mispricing of equities caused by noise traders and further eliminate the appearance of 

mispricing from the stock market (Degutis & Novickyte, 2014). 



37 

Even though the efficient market theory has been the foundation of classical finance for 

a long time. In literature, the efficient market theory has been constantly under 

inspection. Jegadeesh and Titman (1993) present evidence that by buying past winner 

stocks investors are able to generate excess return. Even though, according to the 

efficient market hypothesis, investors should not be able to do this. In the article, this is 

traced back to an anomaly called momentum, which has been caused by the delayed 

price reaction to relevant information (Jegadeesh & Titman, 1993). In addition, the 

changing investment criteria and introduction of corporate sustainability metrics bring 

new difficulties in forming accurate stock prices.  According to Bofinger et al. (2022), 

firms' ESG performance and corporate sustainability strengthen the misevaluation of a 

firm’s market value. This results in already overvalued firms being even more overvalued. 

Whereas an undervalued firm’s valuation gradually moves closer to the true value, 

making their pricing more accurate. This impact of misevaluation can possibly be traced 

back to the trend of sustainable investing or the benefits investors gain from the risk-

decreasing effects of corporate sustainability (Bofinger et al., 2022). Therefore, this 

indicates that stock price developments could be explained with both traditional and 

behavioral finance theories. 

 

 

3.2 The modern portfolio theory  

In the traditional finance literature, it is presented that the main goal of rational investors 

is to maximize their returns on the stock market. This allegation is supported by the 

modern portfolio theory which was first developed by Markowitz (1952). The main 

objective of this theory was to establish principles of profit maximizing asset allocation. 

As a foundation for the theory Markowitz (1952) assumes that investors aim for profits 

and try to avoid variance as much as possible. He suggested that portfolio construction 

should be a choice of the mean-variance ratio to the desired level. The theory works as 

a framework how to maximize the expected return with the smallest possible variance 

by selecting uncorrelated stocks for the portfolio. Furthermore, this framework led to 

the discovery of the efficient frontier which illustrates the maximum expected rate of 



38 

return with a certain level of risk. The graph of efficient frontier provides a selection of 

different possible portfolios with different weights of assets which from investors can 

choose the portfolio that suits their risk preferences. The theory is based on the 

importance of diversification. Therefore, how assets move relative to each other is 

highlighted to investors. It is emphasized that the portfolio should be constructed as an 

entity rather than selecting individual assets by their unique characteristics (Markowitz, 

1952). 

 

This theory has remained a cornerstone of portfolio construction for decades. However, 

the theory has several deficiencies that complicate the effortless appliance of the theory 

on the stock market. Elton and Gruber (1997) argue that the framework is constructed 

for a single decision period, which makes it harder for investors to utilize it because in 

reality they are faced with a multiperiod nature. This problem could be fixed by treating 

reality as a series of single periods. However, that solution would require that return and 

variance should be independent of other periods which is not the case (Elton & Gruber, 

1997). Therefore, it is important to keep in mind the reality investors face when applying 

theories to the stock market. All in all, this theory illustrates how investors incorporate 

the threat of increasing risk in their investment decisions.  

 

The modern portfolio theory has also been adapted to responsible investing. Pedersen 

et al. (2021) performed a valuation on how ESG affects the size of required return by 

forming the ESG-efficient frontier. Therefore, providing investors with additional 

information on how to take ESG performance into consideration while maximizing the 

risk and return of the portfolio. ESG performance provides new non-financial 

information that can affect the risk-return tradeoff differently. The ESG performance of 

the company has both benefits and costs which need to be realistically evaluated. 

According to Pedersen et al. (2021), responsibility preferences can be detected as a 

decrease in the Sharpe ratio when a portfolio with better ESG performance is 

chosen.  However, when the ESG performance is even further increased there is only a 

slight decrease in the portfolio Sharpe ratio (Pedersen et al., 2021). Similarly, López Prol 



39 

and Kim (2022) found lower volatility and even lower returns among portfolios with high 

ESG performance. To conclude, ESG performance creates new dimensions to consider 

with portfolio construction when aiming for maximized risk-return tradeoff. 

 

 

3.3 Behavioral finance perspective 

When examining the effects of certain risks on the stock market it is important to 

understand the underlying reasons for investor decisions. Where traditional finance 

makes the presumption of complete rationality of investors and a consistent tendency 

to maximize the return on investments, the behavioral finance takes a more realistic 

stance on the behavior of investors (Ritter, 2003). According to Ritter (2003), psychology 

literature has documented that people are proven to be prone to make systematic errors 

in decision making processes. Investors can be overconfident, or their personal 

experiences can distort the weight put on certain pieces of information (Ritter, 

2003).  This can cause irrational investment decisions and behavioral biases. Also, De 

Bondt (1998) elaborates that irrational behavior can cause changes to trading habits, risk 

management, and perceptions about market prices and values.   

  

Currently, there are many tools and guidelines available for investors to help determine 

the accurate value of investments and how certain risks would affect the return on their 

investments. However, not all investors are financial professionals and these complicated 

valuation tools can be hard to use (De Bondt, 1998). As a result, investors might base the 

valuation of an investment on a general impression of the company’s value. This creates 

a dilemma because even if the company seems to have a good reputation, it might not 

indicate that investing in company stocks is profitable. As De Bondt (1998) points out, 

this kind of optimistic behavior can lead to the overvaluation of assets. In addition, 

forecasting the direction equity prices are going to take is often based on the previous 

fluctuations of the equity price (De Bondt, 1998). This might not have any rational 

justifications as price developments should reflect new information. Still, investors make 

conclusions based on their personal expectations. 



40 

In literature, it has been noticed that investors have a subconscious tendency to treat 

outcomes differently (Ritter, 2003). Investors seem to experience losses much heavier 

than the same-size profits. These experiences further shape the future decisions and 

preferences of investors. According to Kahneman and Tversky (1979), investors have 

been noticed to avoid losses which has an impact on how investors perceive different 

risk levels. This loss aversion behavior has been tested in a situation where an investor 

has to choose among two options with the same expected result. Investors chose the 

option with a certain loss rather than an option with a smaller risk of losing a bigger 

amount (Burton et al., 2013). 

 

The rationality cannot be assumed even with the most common investment advice. For 

example, diversification is the easiest way to reduce risk among investments as it reduces 

the effect of a realized idiosyncratic risk on the investment (Barber & Odean, 2013). Even 

though many investors are risk averse and aware of this simple way to reduce investment 

risk levels they do not implement it. Barber and Odean (2013) explain this by 

characterizing that it is common for uneducated investors to feel safer while investing in 

domestic assets that have the same communicative language and familiar culture. On 

the other hand, investors might believe they can avoid the risk with other means than 

diversification. De Bondt (1998) argues that some individual investors believe in other 

risk mitigating techniques such as effective trading expertise. Investors seem to believe 

that they can evert risk realization by selling quickly. This is based on an illusion of 

liquidity. This example illustrates that not all investors are able to process information 

about risk with the same capacity.  

 

Also, investment decisions are not always driven by only financial information. In 

literature, Pasewark and Riley (2010) show that another leading factor of investments 

can be investors' personal values. Social responsibility causes investors to search for 

investments that represent the values they think are important. This has been noticed 

when examining the investors' decisions between two investment alternatives that have 

a similar return, but the other alternative is in contradiction with the investor’s values 



41 

(Pasewark & Riley, 2010). This tendency has been widely noticed as more sustainable 

investment options have become available and investors have been very eager to use 

the opportunity. Raut et al. (2023) argue that social motivation and sense of 

responsibility play a significant role in the growing popularity of ESG stocks. Investors 

have developed a green preference as they want to participate in the mitigation of 

climate change. 

 

 

3.3.1 Market participants  

Investors can be mainly sorted into two different groups. It is important to understand 

the characteristics of these groups to be able to evaluate their role in the perception of 

climate risk. There are institutional and retail investors who both influence the stock 

market. This influence results from trading behavior that is typical to the specific market 

participants. Among both groups, there are own characteristic downsides. Still, the two 

investor groups are closely intertwined as many individuals choose to invest through the 

institutions.  

 

Retail investors invest in equities directly by themselves with their own capital. As they 

trade equities in smaller volumes, they hold much smaller parts of a company. In 

addition, trading in smaller amounts and values, the effect of transaction expenses is 

much bigger (Barber & Odean, 2013). This could occasionally affect their trading 

decisions. It can be assumed that not all retail investors are professionals and without 

proper knowledge, they are more prone to make irrational investment choices. Barber 

and Odean (2013) state that many things can influence investment decisions with retail 

investors. For instance, living location and place of work can affect the development of 

portfolio structure. Investors might invest in local entities or even in their own 

employer’s company. This causes trouble with diversification. Another example is that 

the media has been able to increase investors' willingness to buy stocks of frequently 

mentioned companies (Barber & Odean, 2013). Even though this might not have an 

actual financial reason to be affecting portfolio construction. 



42 

The growth of institutional investing has been noticeable, and many individuals are more 

likely to choose the option to invest through different institutions (Kalcheva et al., 2020). 

These institutions can be for example banks, pension funds, hedge funds, and insurance 

companies. Institutions have massive resources and a cluster of financial professionals. 

For inexperienced investors, this alternative is much more effortless to carry out, as 

investing in equities requires knowledge and commitment. Investors would need to be 

constantly updated on the latest market developments and news regarding equities. 

According to Kalcheva et al. (2020), individuals might have determined that it is more 

profitable to depend on the skills of investment professionals. Behind these investing 

institutions are investment managers who complete the investment selection processes. 

Managers choose investment targets based on planned strategies and guidelines. Potter 

(1992) mentions that these decisions can be assumed to be superior when compared to 

retail investors' decisions because the dedication towards information searching about 

investments is more extensive.  

  

In addition, institutional investors have a significant role due to their large volume and 

responsibility for the stewardship of these investments. Among institutions, there can 

be variations in management which can be either passive or active. Differences in active 

management can be illustrated by preferences in time horizons and trading methods or 

styles. Bushee (2004) labels three groups among institutional investors as “transient”, 

“dedicated” and “quasi-indexer”. Transient institutions trade their equities more 

frequently and have small shares in companies. Dedicated institutions maintain steady 

holdings and have stronger positions in companies. Quasi-indexer institutions are a 

combination of these two, they maintain steady holdings and have small shares in 

individual companies. As for investment portfolios under passive management, 

managers invest automatically in companies that are included in a certain equity index. 

The interest in this option has increased substantially and has kept growing (Bebchuk et 

al., 2017). 

 



43 

As institutional investors can hold many shares of a certain company on behalf of 

individual investors, the shareholding is distinctly concentrated. This phenomenon can 

be quite beneficial if the responsibilities of investment stewardship are fulfilled. These 

responsibilities consist of attending meetings of shareholders, voting rights 

implementation, and monitoring the management (Nguyen & Shiu, 2022). With more 

concentrated ownership, there will be a bigger weight on the opinion presented by 

institutional investors. If the responsibilities are not fulfilled, an agency problem might 

be created. This problem illustrates that if both shareholders and companies are utility 

maximizers, there is a reason to believe in the possibility of management not always 

operating in the best interests of the shareholders (Jensen & Meckling, 1976).  

 

The causes of the agency problem are linked to the underlying structure of institutional 

investors. However, Bebchuk et al. (2017) state that there is a need to add transparency 

related to stewardship. Investment managers would need to inform their relationships 

with the companies they have invested in. As the stewardship of investments is time 

consuming, the creation of agency problems can be partly caused by the lack of 

incentives aimed toward managers (Bebchuk et al., 2017). Especially, with the increase 

of index funds, the management compensation has decreased. Investment managers 

would get nothing to cover the efforts put into this comprehensive governance. This 

would mitigate the influence investors can have on the sustainability of their investments. 

 

 

3.3.2 Theory of herd behavior 

The growing popularity of sustainable investing has been detected as a new trend in the 

stock markets. This trend seems to have an accelerating effect on herd behavior which 

causes investors to favor trading similar stocks (Shi et al., 2024). Herd behavior can unify 

the objectives of investors and furthermore allocate more capital toward sustainable 

investment options. This could assist sustainable development by possibly increasing the 

attention paid to corporate sustainability and ESG related issues. On the other hand, this 

kind of market inefficiency can complicate how socially responsible endeavors are 



44 

incorporated into the valuation of stocks (Shantha, 2019). Therefore, the phenomena 

could be said to have multiple sides.  

 

In general, herd behavior illustrates the tendency for individuals to mimic the actions of 

other individuals (Scharfstein & Stein, 1990). According to Scharfstein and Stein (1990), 

in the stock market, this can be noticed as managers mimic the investment decisions or 

even whole portfolio compositions of other managers. This imitation can be 

implemented even while simultaneously ignoring the fundamental information and own 

private intuition. The behavioral bias can be detected in many different market 

participants, as it is typical for retail investors, portfolio managers, and even for whole 

investment institutions (Shi et al., 2024). 

 

Herd behavior has been a widely researched topic but still there is inconclusive evidence 

about the sources behind it (Spyrou, 2013). However, basic argumentation for this 

behavior stems from psychological and social aspects that are characteristic of human 

beings. Scharfstein and Stein (1990) argue that portfolio managers participate in herd 

behavior to alleviate concerns about their reputation. If managers presented bold 

speculations that differentiated from the market consensus, they could suffer negative 

reputation effects or even get fired (Spyrou, 2013). As they make similar decisions as 

other portfolio managers, it creates an illusion of shared blame if the choices are not 

successful or sustainable. In addition, herd behavior can be temporarily caused by advice 

announced by investment professionals or newsletters (Scharfstein & Stein, 1990). The 

motivation for this can be the belief that other market participants have more extensive 

access to information, which causes investors to neglect their own assessment. Also, 

investors have been noticed to imitate the trading choices of others with the justification 

of extracting additional information from the actions of other market participants (Lux, 

1995).  

 

Herd behavior among investors can be said to be a sign of market inefficiency, as the 

trading is not based on newly available information. Herd behavior is believed to create 



45 

excess volatility in the stock market and be the possible reason behind market 

instabilities (Scharfstein & Stein, 1990; Spyrou, 2013). Investors seemingly tend to think 

as a group, creating widely spread optimism or panic. According to Spyrou (2013), 

economists have suggested that this behavior can be linked to the creation of stock 

market bubbles where stock prices deviate from their intrinsic value. In addition, Bogdan 

et al. (2022) state that herd behavior becomes more pronounced during times of crisis 

which was registered during the COVID-19 pandemic. In times of unstable market 

conditions, the anxiety of investors can drive investors to rely on better informed market 

participants. However, Shantha (2019) argues that with a cognitive evaluation of past 

investment choices, investors can reduce their own behavioral biases. 

 

Even with the possible risks of market inefficiencies, herding towards environmentally 

friendly investment options can be considered as a positive side effect. According to Shi 

et al. (2024) herding towards carbon neutrality seems to be detectable on the Chinese 

stock market. This is linked to the importance of climate concepts and the possibility to 

mitigate the risk of policy uncertainty (Shi et al., 2024). This trend increases the capital 

flow toward environmentally friendly options. However, these inefficiencies play still a 

significant role in how accurately different risks can be priced on the market and whether 

the stock prices can illustrate the fundamental value accurately. It has to be taken into 

account while evaluating climate risk, whether the pricing is truly created by the pricing 

of the risk or is it caused by a behavioral bias.  

 

These behavioral aspects of investors indicate how investors can be motivated to 

participate more in sustainable investing. This motion is supported by the theories of 

traditional finance related to the risk perception of investors. Sustainable investing is 

something to be actively considered by investors because of the change in risk levels 

caused by climate change. However, because of the characteristic deficiencies of 

investors, the transition to sustainable investing and taking climate risks into 

consideration is not as straightforward. Therefore, the effects of increasing climate risks 

need to be evaluated. 



46 

4 Previous research  

The existing research related to the effects of climate risk on the stock market is 

presented in this chapter. Firstly, we will concentrate on the available literature regarding 

climate risk and the pricing of it. After this, the focus will be more on the behavioral 

aspect of investors, as how the general attention and sentiment towards climate change 

affects the stock market. Lastly, there will be an evaluation of the existing evidence of 

performance differences between green and brown stocks. This should provide an 

extensive overview of the recent evidence about the role of climate change on the stock 

market.  

 

 

4.1 Climate risk 

Climate change related risks can be detected entering stock prices in the form of climate 

risk. This climate risk is formed with aspects of physical and transition risks. As a 

theoretical foundation, it has been detected that investors want compensation for the 

risks that they face in the stock market. This view is consistent with the modern portfolio 

theory which indicates that there should be a tradeoff between risk and return. However, 

there is still ambiguity about how climate risk is incorporated into stock prices. According 

to a review conducted by Venturini (2022), researchers have ongoing debates about the 

dynamics behind the pricing and whether it is priced efficiently or even at all. 

Suggestions have been made that climate risk might represent an anomaly, an additional 

source of systematic risk, or a specific risk that could be eliminated with diversification 

(Venturini, 2022). Methods to evaluate the pricing of the risk differ among studies. Some 

studies use extensive illustration of a company's sustainability behavior whereas other 

studies focus specifically on the emissions to illustrate corporate sustainability. Therefore, 

some of the climate risk pricing research focuses on examining the carbon risk, which is 

a more specific part of climate risk.  

  



47 

One way of evaluating the pricing of climate risk is to take a closer look at when the risk 

is incorporated into the stock prices. Venturini (2022) introduces the categorizing of ex-

post and ex-ante basis of climate risk pricing. Ex-ante basis refers to pricing climate risks 

in advance and investors being able to detect what kind of risks a certain asset is exposed 

to. The risk is recognized, and compensation is included in the stock price. However, this 

way of pricing climate risk can be very difficult because the available knowledge is limited 

to the investors and even the professionals are not unanimous. Forecasting of risks is 

especially hard for physical risks. For instance, the correct pricing of acute physical risk 

in advance has proved to be extremely difficult due to the uncertainty of materialization 

(Venturini, 2022). As another timing, the ex-post basis pricing happens after a certain 

risk has materialized. Therefore, this pricing can be considered to be a market reaction 

to the materialization of a specific risk. According to Venturini (2022), pricing seems to 

happen on an ex-post basis especially when the materialization is unexpected. The 

reaction is not always similar and for instance, it can be excessive or even delayed. The 

wrong estimation of these risks and the timing of risk pricing can cause major differences 

between expected returns and realized returns in stocks.  

 

The appearance of climate risk has already been acknowledged over a decade. Chen and 

Gao (2012) break down climate risk as how the risk affects company operations. For 

company operations, the realization of these risks can impact future cash flows. 

Especially, when there is a possibility of growing capital expenditures as companies have 

to adjust their own operations to match the continuously changing regulations and 

legislation (Chen & Gao, 2012). In addition, potential shifts in supply and demand impact 

the performance of the company. There is uncertainty about the prospects of how well 

the company will be able to respond to the changing demands of consumers in the future 

(Chen & Gao, 2012). These aspects have a linear effect on the financial performance and 

stability of the company. According to Chen and Gao (2012), climate risk is priced by the 

financial market as increases in the cost of equity and debt financing. 

 



48 

During recent years, there has been a rapidly growing amount of literature aimed to 

prove the possible pricing of climate risks on the stock market. A considerable number 

of studies have found evidence that climate risk is priced on the stock market. Pástor et 

al. (2022) report finding evidence of a green stock premium which has further increased 

during the last decade. In addition, studies have confirmed that climate risks are being 

priced in the stock valuation depending on the exposure to the risks (Engle et al., 2020). 

Furthermore, this pricing of the climate risk has been shown to create performance 

differences between green and brown stocks (Ardia et al., 2021; Pástor et al., 

2021).  However, some studies have found more specific results about which type of risk 

is being priced. Faccini et al. (2023) found that only transition risks related to climate 

policy uncertainty are priced on the US stock market. Also, Li et al. (2024) highlight the 

importance of transition risk and found that the stocks, that do not respond to the risks 

they face, are valued at a discount. 

 

The conducted research has provided a more comprehensive view of how climate risk is 

being priced in different industries. In the food industry, Hong et al. (2019) find that food 

stock prices tend to underestimate the effects of climate risks. Even though, climate 

change poses an imminent risk to food production, as droughts become more common. 

Therefore, these findings suggest that food stocks are inefficient in the pricing of climate 

risks. Whereas, in other sectors, it is common that the effects of climate risks are 

constantly embedded in prices. According to Dutta et al. (2023), the prices of green 

energy stocks increase significantly during times of increased climate risk and when a 

shift toward renewable energy can be noticed in the energy sector. In addition, the 

popularity of technology sector stocks increases during increased risk attention which is 

possibly caused by the hedging opportunity against climate risk (Dutta et al., 2023). As 

for more polluting sectors, Gong et al. (2023) present evidence that a clear climate risk 

premium can be found in fossil energy stocks. The premium is tightly linked to the level 

of climate risk and therefore, regional differences can be recognized (Gong et al., 

2023).  This illustrates that other industries are more sensitive to climate risk and some 

industries are able to price it more efficiently. 



49 

It is common that climate risk is frequently associated with the emission levels of 

companies and some research papers mainly focus on the carbon risk. Bolton and 

Kacperczyk (2021) report higher returns for stocks of companies that have higher carbon 

emission levels. This is consistent with the assumption that investors demand 

compensation for the carbon risk they face (Bolton & Kacperczyk, 2021). Similarly, Hsu 

et al. (2023) report that stocks related to higher emission levels create higher profitability. 

However, the future expected return of these stocks should be lower as new stricter 

regulations come into force and carbon risk increases (Hsu et al., 2023). According to 

Huij et al (2023), there is evidence that during times of increased carbon risk, the stocks 

with higher exposure to carbon risk have lower returns. Clearly, exposure to carbon risk 

is an important aspect of climate risk. However, this prioritization could underrate other 

aspects of the environmental efforts of companies. Therefore, many studies use other 

measures to get a more comprehensive view of the exposure to climate risk (Faccini et 

al., 2023; Li et al., 2024; Pástor et al., 2021). For example, the measure of ESG ratings 

takes into account a more adverse selection of efforts that reflect the company’s attitude 

towards the climate risk.  

 

The possibility of hedging climate risk is often provided as an explanation for the pricing 

of the risk (Engle et al., 2020; Faccini et al., 2023; Pástor et al., 2021). As green stocks are 

not as strongly exposed to climate risks, they should provide a hedge to the investor 

(Engle et al., 2020). Therefore, green stocks would be an opportunity to minimize the 

effects on return