Does Environmental Policy Uncertainty Hinder Investments Towards a Low-Carbon Economy?

Abstract

We use machine learning algorithms to construct a novel news-based index of US environmental and climate policy uncertainty (EnvPU) available on a monthly basis over the 1990-2019 period. We find that the EnvPU index spikes during the environmental spending disputes of the 1995-1996 government shutdown, in the early 2010s due the failure of the national cap-and-trade climate bill and during the Trump presidency. We examine how elevated levels of environmental policy uncertainty relate to investments in the low-carbon economy. In firm-level estimations, we find that a rise in the EnvPU index is associated with a reduced probability for cleantech startups to receive venture capital (VC) funding. In financial markets, a rise in our EnvPU index is associated with higher stock volatility for firms with above-average green revenue shares. At the macro level, shocks in our index lead to declines in the number of cleantech VC deals and higher volatility of the main benchmark clean energy exchange-traded fund. Overall, our results are consistent with the notion that policy uncertainty has adverse effects on investments for the low-carbon economy hindering progress to address the urgency of climate action.

Analysis of the Impact of Economic Policy Uncertainty on Environmental Sustainability in Developed and Developing Economies

“…Fu et al [3] provided evidence of how EPU impacts CO 2 emissions in Chinese cities. Noailly et al [17] examined how environmental and policy uncertainty influences investments in the US. In a recent study, Mahmoodi and Dahmardeh [18] examined the EKC hypotheses considering the ecological footprint as an indicator of environmental degradation and economic growth in European and Asian emerging economies.…”

Drivers of Realized Volatility for Emerging Countries with a Focus on South Africa: Fundamentals versus Sentiment

“…Furthermore, in light of the recent emphasis on climate finance [58], one could also compare US news on uncertainty surrounding climate risks with the fundamentals and behavioural predictors. Some preliminary evidence in this regard, using the WSJ-reliant metric of climate risks of [59] (WSJ_Engle) over January 1984-June 2017; and the multiple newspaper-based climate policy uncertainty (CPU) index [60] for the period of April 1987-August 2022, the environmental policy (EnvP) index (as well as two sub-topic indexes for renewable energy policy (EnvP_REP) and international climate negotiations (EnvP_ICN)) over January 1981-March 2019, and environmental policy uncertainty (EnvPU) index covering October 1990-March 2019 (with the last four indexes developed by [61]), depicting evidence of predictability over the conditional distribution of the South African stock market RV, as derived from the causality-in-quantiles test of [56]. The evidence of in-sample prediction from these indexes of the US is particularly strong around the median, as can be observed from Table A8 in the Appendix A.…”

“…Climate policy uncertainty (CPU) index is derived fromGavriilidis (2021). Environmental policy (EnvP) index, renewable energy policy (EnvP_REP), international climate negotiations (EnvP_ICN)), and environmental policy uncertainty (EnvPU) index are developed by Noailly et al (2022)[61].…”

Climate‐related risks in financial assets

“…positively exposed assets (for an overview, see Table A3 in the Appendix). Such positive exposure may come in the form of compliance with the EU‐ETS (the European Union's emission trading scheme) (Ravina, 2020; Ravina & Kaffel, 2020), relatively lower emissions (Bernardini et al., 2021; Cheema‐Fox et al., 2019; Monasterolo & de Angelis, 2020; Soh et al., 2017) and renewable energy and cleantech firms (Kempa et al., 2021; Noailly et al., 2021). Almost all papers in this category focus on transition risks, with most contributions studying price effects on stocks (Bernardini et al., 2021; Cheema‐Fox et al., 2019; Ramelli et al., 2019; Ravina & Kaffel, 2020; Soh et al., 2017) and bonds (Ravina, 2020).…”

“…Almost all papers in this category focus on transition risks, with most contributions studying price effects on stocks (Bernardini et al., 2021; Cheema‐Fox et al., 2019; Ramelli et al., 2019; Ravina & Kaffel, 2020; Soh et al., 2017) and bonds (Ravina, 2020). One paper investigates the effect of environmental policy stringency on the cost of debt for non‐renewable energy firms (Kempa et al., 2021); another on the probability to receive venture capital funding when climate sentiments are high (Noailly et al., 2021). Two contributions study the effect of transition risk drivers on the value given by financial risk metrics, that is, the rate of non‐performing loans at banks (Cui et al., 2018) and the systemic risk associated with equity (Monasterolo & de Angelis, 2020), respectively.…”