Carbon-Tax-Adjusted Value
23 Pages Posted: 3 Dec 2021
Date Written: November 30, 2021
Abstract
We examine the effects of incorporating a potential tax on carbon emissions into a value investment strategy. We show that in a portfolio optimization problem, a carbon tax at the stock level is mathematically equivalent to a carbon constraint at the portfolio level. Using this insight we derive a value-carbon efficient frontier that reflects the trade-off between a high value exposure and a low carbon footprint. Empirically we find that carbon taxes up to $100, corresponding to a portfolio carbon footprint reduction of about 50%, have little effect on the characteristics and the performance of the long side of a value strategy. Much more aggressive footprint reduction levels seem unreasonable, as they correspond to extremely high carbon tax levels and performance starts to decay.
Keywords: Carbon tax, efficient frontier, value investing, value premium, decarbonization, sustainable investing, ESG
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation