Carbon-Transition Risk and Net-Zero Portfolios

Net-zero portfolios (NZP), which aim to reduce carbon footprint exposure to zero by a target date, are becoming a popular vehicle to align investors' incentives with climate scenarios. The paper presented in this Decarbonization Seminar/Joint Seminar ZEW and MISES characterizes the decision and timing to divest companies from NZP using a novel forward-looking measure, distance-to-exit (DTE), which calculates the distance, in years, until a company gets excluded from NZP. Companies with greater DTE values have higher valuation ratios and lower expected returns, consistent with the idea that DTE captures carbon-transition risk. The effect is stronger when climate pressure intensifies, and it is robust to various specification choices.