Carbon Pricing versus Green Finance

Abstract

Green finance—including environmental, social, and governance investing and sustainable finance regulations—is widespread, but can it substitute for carbon pricing in fighting climate change? In a unified model, I show that (i) when carbon prices reflect the social cost of carbon, green finance should not be used; (ii) when carbon prices are too low, green finance can implement the social optimum if each firm's cost of capital can be set to itssustainable discount rate, which increases with the ratio of carbon emissions to firm value. I provide calibrations, analyze stranded assets, and present implementations through subsidies or preferential financing for green firms.