  This article studies the impact of carbon risk on stock pricing. To address
this, we consider the seminal approach of G\"orgen \textsl{et al.} (2019), who
proposed estimating the carbon financial risk of equities by their carbon beta.
To achieve this, the primary task is to develop a brown-minus-green (or BMG)
risk factor, similar to Fama and French (1992). Secondly, we must estimate the
carbon beta using a multi-factor model. While G\"orgen \textsl{et al.} (2019)
considered that the carbon beta is constant, we propose a time-varying
estimation model to assess the dynamics of the carbon risk. Moreover, we test
several specifications of the BMG factor to understand which climate
change-related dimensions are priced in by the stock market. In the second part
of the article, we focus on the carbon risk management of investment
portfolios. First, we analyze how carbon risk impacts the construction of a
minimum variance portfolio. As the goal of this portfolio is to reduce
unrewarded financial risks of an investment, incorporating the carbon risk into
this approach fulfils this objective. Second, we propose a new framework for
building enhanced index portfolios with a lower exposure to carbon risk than
capitalization-weighted stock indices. Finally, we explore how carbon
sensitivities can improve the robustness of factor investing portfolios.
