Climate Transition Risk and Economic Repricing: The Financial Valuation of Carbon Exposure

Over the past decade, a growing corpus of empirical and peer-reviewed research has demonstrated that climate transition risk—the economic cost of shifting toward a low-carbon global economy—has become a material factor in asset pricing, corporate finance, and sovereign risk premia. The implications extend far beyond environmental concerns; they reshape the foundations of modern capital allocation, redefining risk-adjusted returns across industries and geographies.

A core finding of recent financial economics research is that firms with higher carbon intensity systematically trade at a valuation discount once credible climate policy trajectories emerge. Empirical analyses using global equity data show that companies with greater exposure to future carbon costs experience higher expected returns (reflecting compensation for transition risk) and lower contemporaneous market valuations. This effect is strongest in markets where climate policy credibility and investor climate awareness are high, underscoring that financial markets now price carbon risk analogously to traditional systemic risks such as inflation or default probability (Bolton & Kacperczyk, 2021; Pástor, Stambaugh & Taylor, 2022).

At the macro level, climate transition risk also manifests in sovereign bond markets. A 2023 IMF cross-country study found that countries more reliant on fossil-fuel exports or with slower decarbonisation trajectories face higher long-term borrowing costs and more volatile risk premia. These effects are empirically linked to investors’ anticipation of stranded assets and fiscal instability under stringent climate policies. Crucially, sovereign exposure to transition risk is not merely an environmental variable but a credit risk variable, influencing capital flows and exchange-rate dynamics (Cevik & Tovar Jalles, 2023).

Furthermore, structural economic modelling reveals that unmanaged transition risk can amplify existing financial fragilities. When policy credibility is low or regulatory transitions are abrupt, firms delay low-carbon investments, households misallocate savings, and banks’ carbon-intensive collateral values depreciate non-linearly. This results in financial instability even without physical climate shocks—what is now termed “transition-induced financial stress”(Battiston et al., 2017; Monasterolo, 2020). The empirical pattern is clear: markets with early and credible carbon pricing experience smoother sectoral adjustments and less macro-financial volatility, while those with policy uncertainty suffer sharper repricing once carbon regulation tightens.

Policy and institutional implications are significant. Monetary and supervisory authorities—such as the Bank of England, ECB, and South African Reserve Bank—now integrate climate transition scenarios into stress-testing frameworks. Peer-reviewed evidence supports this move: scenario-based risk assessment enables earlier repricing, mitigates systemic shocks, and encourages capital reallocation toward lower-carbon sectors. In parallel, firms adopting transparent carbon disclosures (aligned with the Task Force on Climate-Related Financial Disclosures, or TCFD) consistently demonstrate reduced financing costs, confirming that information transparency acts as a financial stabiliser in the climate transition.

In essence, verified academic and institutional evidence now shows that carbon exposure is no longer an externality—it is a quantifiable financial risk. Economies and firms that proactively align their balance sheets with credible decarbonisation paths secure more stable access to capital, while those that delay adaptation face measurable financial penalties. The repricing of carbon is not a distant forecast—it is a live phenomenon shaping today’s macro-financial equilibrium.

Battiston, S., Mandel, A., Monasterolo, I., Schütze, F. & Visentin, G., 2017. A climate stress-test of the financial system. Nature Climate Change, 7(4), pp.283–288.

Bolton, P. & Kacperczyk, M., 2021. Do investors care about carbon risk? Journal of Financial Economics, 142(2), pp.517–549.

Cevik, S. & Tovar Jalles, J., 2023. Sovereign Risk and the Energy Transition: Evidence from Bond Markets. IMF Working Paper No. 2023/013.

Monasterolo, I., 2020. Climate change and the financial system. Annual Review of Resource Economics, 12, pp.399–420.

Pástor, Ľ., Stambaugh, R.F. & Taylor, L.A., 2022. Sustainable investing in equilibrium. Journal of Financial Economics, 145(2), pp.467–496.