Pricing Climate Ambiguity

Francesco Rocciolo, Monica Billio and Massimo Guidolin

Abstract

The theoretical literature on climate finance advocates the existence of a tight relation between climate change and uncertainty of the probabilistic models (ambiguity) concerning future climate-related events affecting consumption opportunities. This paper provides empirical evidence for the relevance of this phenomenon to asset pricing. It finds a transmission channel---ambiguity (Knightian uncertainty)---through which climate change relates to cross-sectional expected stock returns. This paper suggests the existence of a so-far undisclosed climate-ambiguity cross-sectional pricing anomaly. An idiosyncratic cross-sectional climate ambiguity factor explains up to 92% of the abnormal returns linked with the anomaly.