Zhongyi Yuan
Pennsylvania State University
Title
Financed Emissions, Internal Carbon Charges, and Abatement
Abstract
Financed emissions have become the largest component of financial institutions' carbon footprint. We argue that investors' internal management of financed emissions is a distinct channel facilitating the green transition, which differs substantially from the channels investigated in prior work. Using a portfolio selection model, we investigate how the use of internal carbon charges to reduce financed emissions impacts asset prices, investment performance, and abatement in equilibrium. We also endogenously determine investors' internal carbon prices (ICPs), which are found to be inversely related to their target levels of (adjusted) carbon intensity. In addition, we find that the channel's effect on abatement is limited by the low ICPs currently applied to financed emissions. We therefore introduce an engagement model to study how investors engaging with brown firms could improve abatement. Our model reveals that engagement amplifies the effective ICP used by the investor by a factor inversely related to her stake size.
