Carbon allowance and stock return: evidence from EU companies

We investigate the relationship between carbon allowance and stock return. We argue in favor of the expense hypothesis: the relationship between stock returns and carbon allowance is negative due to the greater net impact (operational cost exceeds reputation benefit) of rising carbon price. To verify the hypothesis, we employ the modified Fama French 3 Factor Model. We employed data from 139 European Union companies which comprise 86 Carbon-Intensive (CI) companies and 59 Non-Carbon Intensive (NCI) companies. The data is of monthly frequency from January 2010 to October 2023. Augmented Mean Group estimator is applied due to the presence of cross section dependence and slope heterogeneity. We found that carbon allowance has a significant negative relationship with stock return in Carbon Intensive companies. Our result is robust under an array of checking schemes. The study shed a new light on the field of energy economics, especially on how investor response for carbon allowance adoption by companies.