The Pollution Premium

154 Pages Posted: 12 May 2020 Last revised: 13 Feb 2023

See all articles by Po-Hsuan Hsu

Po-Hsuan Hsu

National Tsing Hua University - Department of Quantitative Finance; National University of Singapore (NUS) - Asian Bureau of Finance and Economic Research (ABFER)

Kai Li

Peking University HSBC Business School

Chi-Yang Tsou

The University of Manchester - Alliance Manchester Business School

Date Written: May 10, 2022

Abstract

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 a given industry generates an average return of 4.42% per annum, which remains significant after controlling for risk factors. This pollution premium cannot be explained by several explanations, including existing systematic risks, investors' preference, market sentiment, political connections, and corporate governance. We propose and model a new systematic risk related to environmental policy uncertainty. We use the growth of environmental litigation penalties to measure regime change risk, and find that it helps price the cross-section of emission portfolios' returns.

Keywords: Toxic emissions, regime shift risk, uncertainty, environmental regulation, cross-section of stock returns

JEL Classification: E2, E3, E4, G1, Q5

Suggested Citation

Hsu, Po-Hsuan and Li, Kai and Tsou, Chi-Yang, The Pollution Premium (May 10, 2022). Journal of Finance, Forthcoming , Available at SSRN: https://ssrn.com/abstract=3578215 or http://dx.doi.org/10.2139/ssrn.3578215

Po-Hsuan Hsu (Contact Author)

National Tsing Hua University - Department of Quantitative Finance ( email )

101, Section 2, Kuang-Fu Road
Hsinchu, Taiwan 300
China

National University of Singapore (NUS) - Asian Bureau of Finance and Economic Research (ABFER) ( email )

BIZ 2 Storey 4, 04-05
1 Business Link
Singapore, 117592
Singapore

Kai Li

Peking University HSBC Business School ( email )

+86 755 26032023 (Phone)

HOME PAGE: http://sites.google.com/site/kailiwebpage

Chi-Yang Tsou

The University of Manchester - Alliance Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

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