Dirty Stock Returns in the Era of Sustainability: A Study of the World's Largest Carbon Market

Sammanfattning: Using a dataset on the stock returns of 65 German firms, this thesis empirically analyses the effect of the European Union Emissions Trading System on the biggest economy and carbon market in Europe. We conclude that the different allocation methods have resulted in large discrepancies in stock performance for the firms reporting under the ETS. More specifically, we find a statistically significant premium in stock returns for carbon emitting firms when carbon allowances are freely allocated. This is due to two economic mechanisms, namely the cash-flow effect and the carbon risk effect. When allowances are sold in auctions as opposed to being allocated for free, this premium dissipates, and clean firms outperform dirty firms. In short, this thesis contributes to the evaluation of the world's largest carbon market and its effect on the financial performance of firms reporting under the system.