The Role of Environmental Factors in Explaining Return Variation in Equity Markets

Abstract

This study investigates whether environmental factors help explain return variation in equity markets, and if so, whether this relationship reflects a climate-related risk premium or investor preferences. We use the Refinitive ESG database (2025) to construct our own environmental score, which is then incorporated in a Green Minus Brown (GMB) factor. The time span for our study is 2015 to 2024. Our findings indicate that there is a varying time effect: prior to 2020, environmental performance had limited influence on returns, while after 2020, the GMB factor provided meaningful explanatory power for several portfolios. This suggests a growing market relevance for environmental characteristics in recent years. We also observed that green stocks tended to be most large-cap while brown firms were often small-cap. Our study contributes to the growing literature by showing that the explanatory power of environmental performance has grown over the years. However, our Fama–MacBeth regression results indicate that the GMB factor is not a priced risk factor in a cross-sectional sense. Further research is needed to assess whether these patterns hold across other markets and longer time periods.