Mental Models in Financial Markets: How Do Experts Reason About the Pricing of Climate Risk?

We study experts’ beliefs about how climate risk is priced in equity markets and how these beliefs shape return expectations. Using a comprehensive survey, we show that most experts believe climate risk is insufficiently reflected in prices, but disagree about its source and persistence. Analyzing text responses, we identify distinct mental models professionals use to assess pricing implications of climate risk. These models explain heterogeneity in short- and long-horizon return expectations and map to specific pricing channels. Mental models vary systematically with experts’ political orientation and geography. An information experiment shows that a prominent second-order-belief model causally affects return expectations.