Is climate policy uncertainty positively or negatively priced in the stock market, and why?

Liang Wu, Binwei Xu and Meng Han

Journal of Risk

Abstract: This paper investigates Chinese climate policy uncertainty (CCPU) as a systematic risk factor within the intertemporal capital asset pricing model framework. We establish that CCPU carries a significantly negative risk premium in the cross section of Chinese stock returns. Industry exposure analysis reveals the economic mechanism underpinning this result: assets with positive CCPU betas, predominantly in green sectors, serve as hedges against deteriorations in the investment opportunity set. Further, we demonstrate that rising CCPU predicts lower future aggregate market returns and higher volatility, signaling deteriorating investment conditions. This predictive power fundamentally explains the observed negative premium, as investors accept lower returns for holding hedging assets that provide protection against CCPU.

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