Boswijk, H., Diks, C., Trimborn, S. and Valle, M. (2026). Environmental regulatory risk Energy Economics, 163.

The aim of this paper is to determine from market expectations how firms are affected by risks arising from environmental regulation. We use a text-based measure of environmental regulatory stringency derived from U.S. EPA legal documents and industry-level relevance scores to capture time-varying regulatory stringency exposure. We find that environmental regulatory stringency carries a positive and statistically significant return compensation, especially for firms with high cash holdings. For firms with low cash holdings, the effect is highly volatile, showing investors are uncertain about a firm{\textquoteright}s future when faced with stricter regulation. Firms{\textquoteright} environmental profiles further matter, as high-emission firms{\textquoteright} returns are negatively affected when regulatory stringency increases. Because regulatory text is released infrequently, challenging real-time risk analysis, we utilize our studies insights to derive a high-frequency, market-expectation capturing Environmental Regulatory Risk Index (ERRI). We show that ERRI captures shifts in investors{\textquoteright} expectations of environmental regulatory stringency and how ERRI reacts during environmental policy and political developments.