How big is the carbon bubble really?

Abstract

We examine how major U.S.-listed fossil fuel firms respond to discrete climate policy signals, including annual United Nations climate summits and four major policy announcements, by estimating market-implied valuations under business as usual (BAU) and policy-adjusted scenarios and the associated carbon bubble. Using data from the stock and options markets, we infer the value of the carbon bubble as the difference between the observed market price and policy-adjusted valuations. This study finds that the carbon bubble corresponds to 5.5% of current firm value, or approximately $99.3 billion, suggesting that markets perceive moderate downside risk from regulatory and policy shifts. Firm-specific analyses, including Exxon Mobil, indicate that climate policy events can materially influence risk distributions, with 5% value-at-risk estimates under BAU scenarios ranging from 12% to 45% under policy-adjusted scenarios. These findings highlight that financial markets systematically incorporate climate policy developments into firm valuations while indicating the overall resilience of fossil fuel assets under both BAU and policy-adjusted scenarios.