Climate Risk in Asset Pricing: Reassessing Industry Equity Capital Costs via Improved CAPM

Climate change poses significant risks to financial markets, yet traditional asset pricing models like the Capital Asset Pricing Model (CAPM) fail to incorporate these factors. This study extends the CAPM by integrating physical and transition climate risks to evaluate their differential impacts on the cost of equity across high-carbon (energy and materials) and low-carbon (technology and consumer discretionary) industries. Using historical data from 2012 to 2024, we employ regression analysis to estimate climate-adjusted betas and assess cost of capital adjustments under varying policy scenarios. Results indicate that high-carbon sectors exhibit heightened sensitivity to both risk types, leading to elevated equity costs, particularly under stringent 2C policy pathways. These findings offer implications for investors, companies, policymakers, and future research in climate-finance integration.