How do carbon prices impact carbon premium?

Carbon price and carbon premium? What’s the difference? One is the measure by which governments use to curb emissions – carbon price. If you as a source emit more , expect to pay more. This is usually in the form of taxes or an emission trading scheme. 

The carbon premium instead is how much investors are willing to pay for lower emitting firms and avoid higher emitting ones. This premium is usually positive for higher emitting firms, which means these firms have lower ex-ante prices. Investors bear the additional climate change risks from holding onto these pollutive firms.

How do carbon prices affect carbon premium? In my research with my coauthor Kang, I find there is a positive correlation between the carbon premium and carbon prices but only for firms in the brown industries – energy, utilities and basic materials. 

This has important implications as governments seek to adhere to binding quotas through increased carbon pricing. 

The research validates that with higher carbon prices, investors would take on more risks buying into more emitting firms. 

A link to the paper is here. 

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