The financial uncertainty of climate-related assets: A factor stochastic volatility approach

We measure common financial uncertainty across climate-relevant assets and study its relationship with the market volatility of green and brown firms. Using a factor stochastic volatility model, we first construct an econometric measure of aggregate uncertainty for assets involved in the climate transition, then we decompose total uncertainty to extract "uncertainty factors", defined as components that reflect common uncertainty shocks across different asset classes. We investigate the empirical relationship of these factors with the option-implied volatility of stocks. One factor emerges as a robust predictor of the excess volatility of brown stocks relative to green ones, especially for longer option maturities. Further analysis suggests that this factor captures the financial-uncertainty dimension of the climate and energy transition.