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| Type | Master's Thesis |
| Scope | Discipline-based scholarship |
| Title | The Pollution Premium Evidence from European Equity Markets |
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| Institution | University of Zurich |
| Faculty | Faculty of Business, Economics and Informatics |
| Number of Pages | 65 |
| Date | 2021 |
| Abstract Text | This thesis aims to find empirical evidence for a pollution premium in European equity markets. To do so, different methods are applied, including a portfolio study, a Fama-MacBeth factor regression, and an event study. These methods do not confirm the existence of a pollution premium. Green stocks outperformed brown ones significantly in the portfolio study. The factor regression and the event study fail to provide evidence of a pollution premium. The author suspects that the results differ from expectations due to an ongoing change in investors’ preferences that prevents the market from settling in an equilibrium. |
| Zusammenfassung | Contemporary literature provides theory and empirical evidence of a so-called pollution premium. It supposes that securities of firms that are emitting more greenhouse gases require a higher rate of return. While there are several explanations for the existence of this premium, two channels are predominantly found in studies. First is transitional risk: the increased risk by exposure to potential restrictive regulations and policies. Such policies would impact the profitability of polluting firms, which decreases their value. Second is the investor recognition channel: scarcity of capital, stemming from the abstaining of environmentally responsible investors, leads to higher expected returns as the stocks’ prices are depressed due to decreased demand and the idiosyncratic risk being no longer diversified. This thesis aims to find empirical evidence for a pollution premium in European equity markets, since other literature mainly focuses on the United States. To accomplish this, different tools and methods are applied. First a portfolio sorting based on emissions in the individual industry groups leads to a zero-cost portfolio that is long on high-emissions stocks and short on low-emissions stocks. Against expectations, this portfolio does yield very significant negative returns. In other words, the low-emissions stocks outperform the high-emissions ones. Secondly, to analyze the matter in depth, a firm-level regression of returns on emissions and different control variables is used. The regression follows the two-step Fama-MacBeth procedure. This method shows that a premium does not arise when controlling for size and value. It seems that greenhouse gas emissions are, against expectations, not a premium bearing risk factor. Finally, an event study is conducted to demonstrate whether the manifestation of policy risk leads to a change in the valuation of emission-intense stocks. The chosen event is the European Parliament election. The European green parties exceeded expectations and won 24 seats. This leads to the assumption that more restrictive environmental policies are to come, which should have an impact on polluting firms. This is, to the author’s knowledge, the first stock price reaction analysis of that event. Cumulative abnormal returns, however, do not differ between high- and low-emissions stocks. All these methods are supplemented by extensions and additional tools. Assessing these results, the author suspects that an ongoing trend towards green assets and changes in investors’ preferences combine to prevent the market from finding an equilibrium. Realized returns do not equal expected ones. Future research may be able to dissect the effects from the changing preferences and the actual equilibrium mechanisms. It is surely worthwhile to pursue further research in this matter. |
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