Climate policy uncertainty and the cross-section of stock returns

We show that climate policy uncertainty (CPU) is priced cross-sectionally in individual stocks. On average, the risk-adjusted annual future returns of stocks with low exposure to CPU are 5.5%- 6.3% higher than those of stocks with high CPU exposure. This finding is consistent with Merton's (1973) intertemporal CAPM where uncertainty-averse investors are willing to pay higher prices and accept lower future returns for CPU-sensitive stocks. Low CPU-beta firms are primarily value stocks with low crash risk, and they have higher exposure under Democratic presidencies. Finally, we develop a novel CPU factor, and show that it outperforms the size and value factors.