The Network Origins of the Carbon Risk Premium

Carbon risk is shaped not only by firms’ own emissions but also by their position in production networks. We develop a general-equilibrium asset-pricing framework with input–output linkages, carbon emissions, and aggregate regulatory risk, and derive a sufficient-statistic characterization of the carbon risk premium in terms of direct exposure ? and indirect network exposure ?. Empirically, ? dominates ? in the cross-section of expected returns and accounts for roughly 85% of the total carbon risk premium. Using a Carbon Regulatory Index constructed from textual sources, we show that high- ? firms contract sharply in valuations, investment, and earnings during regulatory-risk episodes. The incidence is strikingly asymmetric: “network-brown” firms—low direct emissions but high network exposure—produce under 2% of aggregate Scope 1 emissions yet bear about 27% of the aggregate carbon risk premium. In a networked economy, emissions are governed by ?, but carbon-policy risk is governed by ? + ?.