Executive Summary:
This paper aims to measure and assess the impact of Canadian climate transition policy risk on the return and volatility of green vs brown firms. Using a novel classification of Canadian climate policies and an encompassing definition of climate transition policy risk (CTPR), the author constructs a monthly Canadian news-based CTPR index (CDN-CTPR) by performing textual analysis on six leading Canadian newspapers between April 1988 and December 2024. Using data on green and brown firms in the TSX/S&P composite index, the author employs the constructed CTPR index in an econometric volatility model to test (1) the hypothesis that green firms outperform brown firms when concerns about climate change that are exacerbated by climate policy rise unexpectedly, and (2) the hypothesis that green firms are more resilient to climate policy risk as opposed to brown firms in the sense that green (brown) stocks exhibit a decrease (increase) in volatility following increases in such risk.
The findings support both hypotheses. When the CDN-CTPR index strengthens, green firms deliver higher returns than brown peers. Contemporaneous increases in the index are associated with decreased volatility for green stocks and increased volatility for brown stocks, underscoring the relative resilience and adaptability of green firms to the low-carbon transition.
Implications for researchers, Canadian policymakers, regulators, and market practitioners include: (i) using the CDN-CTPR index as a practical tool to measure and manage climate policy risk; (ii) extending analysis to other macroeconomic and financial variables; and (iii) complementing market signals with targeted policy levers—such as tax incentives, credits, and other forms of support—to accelerate the transition for high-emitting firms. While a high-return, low-volatility profile can motivate change, credible and stable policy actions that reduce uncertainty and promote market stability are vital to an orderly transition to a low-carbon economy.
These findings are notable for financial executives: when climate policy risk intensifies in the news cycle, Canadian green firms consistently deliver higher returns and lower volatility, while brown firms exhibit the opposite pattern—higher volatility and weaker performance. This suggests that markets are already differentiating between transition leaders and laggards, rewarding firms that are more adaptable to a low-carbon economy.
For risk managers, this highlights the potential of the CDN-CTPR as a forward-looking risk indicator to integrate into stress testing, portfolio monitoring, and capital allocation decisions. For asset managers and lenders, it underscores the value of identifying firms with credible transition strategies, not only for ESG alignment but also for financial outperformance and downside protection. And for boards and policymakers, the evidence demonstrates that credible, stable policy signals can reduce systemic volatility and accelerate the green transition by reinforcing market confidence.