Climate Adequacy and Market Risk: Are They Related? Empirical Evidence From the European Equity Market Before and After the Adoption of the Paris Agreement

ESG ratings, and in particular environmental scores (E-scores), are becoming increasingly relevant for financial stability andcapital allocation decisions. This paper investigates the relationship between corporate environmental performance and marketrisk, as measured through value at risk (VaR) and expected shortfall (ES), the key metrics used in prudential banking frame-works to assess market risk and determine capital requirements. We also explore whether this relationship has evolved followingthe Paris Agreement and examine firms' behaviour during periods of financial stress. Using a sample of companies from theSTOXX Europe 600 index over the period 2008–2022, we find that the relationship between higher E-scores and market riskchanges significantly over time, becoming negative following the Paris Agreement. Additionally, firms with higher E-scoresdisplay greater resilience during periods of market stress, showing faster adjustments back to pre-shock conditions. These re-sults imply that banks, investors and asset managers should reorient portfolios towards environmentally sustainable assets tostrengthen market resilience and performance. However, the most novel contribution is for policymakers and banking supervi-sory authorities. The consistent link between higher E-performance and lower regulatory market risk contributes to the ongoingdebate on whether and how sustainability-related factors should be reflected in prudential regulation, including proposals suchas a green supporting factor. Such mechanisms could encourage banks to allocate a greater share of credit to environmentallysustainable activities while maintaining sound risk management standards