Not Just Knocking on Wood: The Short- and Long-Term Pricing of Deforestation Risks on Global Financial Markets

The Financial Risks of Deforestation: A New Lens on Corporate Exposure

Deforestation is not only an environmental crisis but also, increasingly, a significant financial risk. As global efforts to curb biodiversity loss intensify, regulators have started to scrutinise companies with high deforestation exposure. Our research introduces the Corporate Deforestation Exposure (CDE) metric, a novel tool that quantifies corporate exposure to deforestation risks, and examines its impact on financial markets both in the long and short term. We compute the CDE metric for all non-financial companies in the MSCI ACWI and examine whether financial markets price in companies deforestation exposure.

Key Findings

1. Long-Term Financial Impact

We constructed a Brown Minus Green (BMG) portfolio, which goes long on high-deforestation-risk stocks and short on low-risk ones, to assess whether deforestation risk is priced in financial markets.

From 2013 to 2022, the BMG portfolio exhibited on average negative returns, indicating that companies with high deforestation risk did not have to compensate investors for their deforestation exposure and the potential associated risks.

However, recent trends suggest an increasing awareness among investors, with positive (though not significant) alpha emerging in the past few years. This might be due to a change in investor expectations and could imply a compensating risk premium in the future.

2. Short-Term Market Reactions

We conducted an event study on the December 2022 trilogue agreement of the EU Deforestation Regulation (EUDR), which significantly raised regulatory risks for companies dependent on deforestation in their business operations.

Our findings show that companies with high CDE scores experienced statistically significant stock return losses following the agreement, suggesting that financial markets respond to unexpected regulatory shifts.

3. A Distinct and Material Risk

Our analysis shows that deforestation risk is financially significant and cannot be explained by broader climate or biodiversity shocks. The return patterns of the BMG portfolio suggest that deforestation is not just another ESG concern, but a separate, material risk that investors must address independently.

Why This Matters

For Investors: Deforestation risk is distinct from general climate or biodiversity risks and requires targeted strategies to mitigate financial exposure.

For Policymakers: Regulatory actions such as the EUDR have real financial consequences, reinforcing the role of policy in shaping corporate behaviour.

For Companies: Firms with high deforestation exposure face growing risks from regulatory fines, supply chain disruptions, and reputational damage.

Conclusion & Policy Implications

Our study highlights the need for greater transparency and risk assessment in financial markets concerning deforestation. While the long-term pricing of deforestation risk remains ambiguous, short-term market reactions suggest that policy shocks play a crucial role in shaping investor expectations. Going forward, improving deforestation risk disclosure and integrating such risks into financial decision-making will be key to fostering sustainable corporate practices and resilient financial markets.

Bohnet, Marc-Philipp and Fliegel, Philip and Tax, Tycho, Not Just Knocking on Wood: The Short-and Long-Term Pricing of Deforestation Risk on Global Financial Markets (February 25, 2025). Available at SSRN: https://ssrn.com/abstract=5155518 or http://dx.doi.org/10.2139/ssrn.5155518