Pricing of Green Regulatory and Technological Risks

Do political shifts impact the value of green innovation?

Hélène Mathurin investigates how firms' exposure to environmental regulations and green technologies translates into risk premia in Pricing of Green Regulatory and Technological Risks. »

Using text analysis of U.S. firms' press releases between 2008 and 2023, she constructs monthly indicators of regulatory and technological risks and examines their relationship with firm returns under different political regimes:

• Firms with high exposure to regulatory risks earn 1.5% higher expected returns under Democrat administrations but underperform under Republican leadership.
• Firms investing in green innovation face a 3.5% lower expected return under Democrat governments but outperform under Republican administrations.
• The regulatory and technological risk premia exhibit a -53% correlation, meaning that when regulatory risks increase, technological opportunities decrease.
• Political influence on climate risk premia is statistically significant, with stronger effects when the presidency aligns with a supportive Congress. A divided government leads to smaller risk premia fluctuations.
• Empirical findings are supported by a consumption-based asset pricing model, which captures the relationship between regulatory shocks, green innovations, and their impact on firms' cost of capital.

This article suggests financial models must evolve to reflect political shifts. Portfolio managers can optimise returns by adjusting sector exposure based on anticipated policy changes, or by incorporating regulatory risk indicators into valuation models.

The study's US focus may however not be representative of international variations in policy stringency and their impact on green innovation.

Additionally, press release data may not fully reflect firms' actual regulatory and innovation risks, as corporate communications are often strategically framed.