Climate Disasters, Carbon Dioxide, and Financial Fundamentals

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I propose a rare disaster model of an economy where the probability and intensity of climatic disasters are proxied by CO2 levels that are determined by inputs of carbons from the firms in the economy. Disasters affect the budgets, the labor allocations and investment decisions of households; the production and investment decisions of firms; and, monetary policy. Six propositions are developed relating carbon dioxide and climatic economic damages to financial variables: the risk-free rate, the price dividend ratio, and the risk premium. The six propositions are tested empirically using a unique data set for the United States over the period from March 1958 to December 2018. The data support the six propositions. For the strongest results, the carbon dioxide levels in the atmosphere are negatively related in the long run to the risk-free rate. Carbon dioxide levels are positively related to the risk premium in the long run.