The Pollution Premium
102 Pages Posted: 12 May 2020
Date Written: April 17, 2020
This paper studies the asset pricing implications of industrial pollution. A long-short portfolio constructed from firms with high versus low toxic emission intensity within industry generates an average return of 4.42% per annum, which remains significant after controlling for risk factors. We examine several possible explanations for this pollution premium, which include policy uncertainty with respect to environmental regulations, relatedness to existing systematic risks, investors' preference for social responsibility, market sentiment, political connection, and corporate governance. Our empirical evidence suggests that the pollution premium is attributable to environmental policy uncertainty, which constitutes a systematic risk in a general equilibrium model.
Keywords: Toxic emissions, regime shift risk, uncertainty, environmental regulation, cross-section of stock returns
JEL Classification: E2, E3, E4, G1, Q5
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