Accommodative monetary policy and the pricing of climate change.

Context and objectives: This paper proposes to study the relationship between asset returns and unconventional monetary policy. There is a growing literature on climate change and the risks induced by it (physical risk and transition risk). However, there are still very few studies linking the main instrument of unconventional monetary policy, namely quantitative easing, to equity returns. Indeed, when conventional monetary policy tools are no longer effective to boost economic activity, central banks may resort to temporary (so-called unconventional) tools to re-establish monetary policy transmission channels. By definition, central banks inject liquidity into the economy by buying securities on the markets. As a result, one might ask whether this influx of liquidity would impact asset prices by remunerating them. In other words, quantitative easing (QE) might crush risk premiums, particularly those related to climate change. Thus, our paper is at the intersection of two literatures. On the one hand, the one stressing the impact of climate change on finance, especially concerning the pricing of climate risks on markets, and on the other hand the one which focuses on the crushing of risk premium related to unconventional monetary policy. Methodology & Data: The paper is structured around a theoretical model and an empirical application. The theoretical model is decomposed into two steps where we propose in the first step to price the climate risk on financial markets, and in the second step to measure the impact of quantitative easing on the risk premium associated with risk pricing (called the carbon premium). The empirical application concerns 31 countries over the observation period from 2010 to 2020. We estimate a model with panel data with sector and time fixed effects. Carbon emissions data and firms' equity returns are obtained from Datastream. The main idea is i) to capture the relationship between prices and climate risk through the beta of a regression of price returns on a climate risk exposure over a cross section of sectors, for a given country i at a given year t; before ii) regressing the obtained betas on the unconventional monetary policy of the country i at time t. Conclusion: This paper shows that QE can hamper the efficient pricing of climate risk by reducing the informative content of prices. This effect disappears when QE becomes tapered, which involves a risk in term of short-term prices adjustments. The idea of underpinning monetary policy to climate risk would help to remove the distortive effect of QE on risk premia while maintaining an accommodative stance on aggregate. [ABSTRACT FROM AUTHOR]