We study whether exposure to marketwide correlation shocks affects expected option returns, using data on S&P100 index options, options on all components, and stock returns. We find evidence of priced correlation risk based on prices of index and individual variance risk. A trading strategy exploiting priced correlation risk generates a high alpha and is attractive for CRRA investors without frictions. Correlation risk exposure explains the cross-section of index and individual option returns well. The correlation risk premium cannot be exploited with realistic trading frictions, providing a limits-to-arbitrage interpretation of our finding of a high price of correlation risk.CORRELATIONS PLAY A CENTRAL ROLE in financial markets. There is considerable evidence that correlations between asset returns change over time 1 and that stock return correlations increase when returns are low. 2 A marketwide increase in correlations negatively affects investor welfare by lowering diversification benefits and by increasing market volatility, so that states of nature with unusually high correlations may be expensive. It is therefore natural to ask whether marketwide correlation risk is priced in the sense that assets that pay off well when marketwide correlations are higher than expected (thereby providing a * Driessen is at the University of Amsterdam. Maenhout and Vilkov are at INSEAD. We would like to thank Yacine Aït-Sahalia, David Bates, Jonathan Berk, Oleg Bondarenko, Michael Brandt, Menachem Brenner, John Campbell, Mike Chernov, Greg Duffee, Darrell Duffie, Rob Engle, Jan Ericsson, Gerard Gennotte, Jens Jackwerth, Chris Jones, Frank de Jong, Hayne Leland, Toby Moskowitz, Anthony Neuberger, Josh Rosenberg, Mark Rubinstein, Pedro Santa-Clara, Ken Singleton, Otto van Hemert, Robert Whitelaw, Zhipeng Zhang, and especially Bernard Dumas for comments and stimulating discussions. We are particularly grateful for the detailed and constructive comments of an anonymous referee and the Editor. We received helpful comments from seminar participants at Berkeley Haas School of Business, BI Oslo, Cornell Johnson School, HEC Lausanne, INSEAD, LBS-LSE-Oxford Asset Pricing Workshop, MIT Sloan, NY Fed, NYU Stern, Stanford GSB, Tilburg,

We develop a method that identifies the attention paid by earnings call participants to firms' climate change exposures. The method adapts a machine learning keyword discovery algorithm and captures exposures related to opportunity, physical, and regulatory shocks associated with climate change. The measures are available for more than 10,000 firms from 34 countries between 2002 and 2020. We show that the measures are useful in predicting important real outcomes related to the net-zero transition, in particular, job creation in disruptive green technologies and green patenting, and that they contain information that is priced in options and equity markets. CLIMATE CHANGE WILL PROFOUNDLY AFFECT the way business is conducted. Scientists have developed complex models that estimate the effect of greenhouse gas emissions on the global climate. At the same time, however, little

Strong regulatory actions are needed to combat climate change, but climate policy uncertainty makes it difficult for investors to quantify the impact of future climate regulation. We show that such uncertainty is priced in the option market. The cost of option protection against downside tail risks is larger for firms with more carbon-intense business models. For carbon-intense firms, the cost of protection against downside tail risk is magnified at times when the public’s attention to climate change spikes, and it decreased after the election of climate change skeptic President Trump.

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We study whether exposure to marketwide correlation shocks affects expected option returns, using data on S&P100 index options, options on all components, and stock returns. We find evidence of priced correlation risk based on prices of index and individual variance risk. A trading strategy exploiting priced correlation risk generates a high alpha and is attractive for CRRA investors without frictions. Correlation risk exposure explains the cross-section of index and individual option returns well. The correlation risk premium cannot be exploited with realistic trading frictions, providing a limits-to-arbitrage interpretation of our finding of a high price of correlation risk.CORRELATIONS PLAY A CENTRAL ROLE in financial markets. There is considerable evidence that correlations between asset returns change over time 1 and that stock return correlations increase when returns are low.2 A marketwide increase in correlations negatively affects investor welfare by lowering diversification benefits and by increasing market volatility, so that states of nature with unusually high correlations may be expensive. It is therefore natural to ask whether marketwide correlation risk is priced in the sense that assets that pay off well when marketwide correlations are higher than expected (thereby providing a * Driessen is at the University of Amsterdam. Maenhout and Vilkov are at INSEAD. We would like to thank Yacine Aït-Sahalia, David Bates, Jonathan Berk, Oleg Bondarenko, Michael Brandt, Menachem Brenner, John Campbell, Mike Chernov, Greg Duffee, Darrell Duffie, Rob Engle, Jan Ericsson, Gerard Gennotte, Jens Jackwerth, Chris Jones, Frank de Jong, Hayne Leland, Toby Moskowitz, Anthony Neuberger, Josh Rosenberg, Mark Rubinstein, Pedro Santa-Clara, Ken Singleton, Otto van Hemert, Robert Whitelaw, Zhipeng Zhang, and especially Bernard Dumas for comments and stimulating discussions. We are particularly grateful for the detailed and constructive comments of an anonymous referee and the Editor. We received helpful comments from seminar participants at Berkeley Haas School of Business, BI Oslo, Cornell Johnson School, HEC Lausanne, INSEAD, LBS-LSE-Oxford Asset Pricing Workshop, MIT Sloan, NY Fed, NYU Stern, Stanford GSB, Tilburg,