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An empirical analysis of climate and environmental policy risk, the cost of debt and financial institutions' risk preferences

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  • Zhou, Xiao Yan
  • Caldecott, Ben
  • Shrimali, Gireesh
  • Zhang, Hanyu

Abstract

This study examines the impact of regulatory risk on the cost of debt and investment preferences across energy sources. We use the OECD Environmental Policy Stringency Index, loan spreads and investment decisions as measures of climate and environmental (CE) policy risk, cost of debt and risk preferences, respectively. We find that the stringency of CE policy risk influences investors' assessment of investment risks and capital allocation across energy sources. In the energy production sector, we observe that greater stringency in CE policies (such as carbon trading schemes) is associated with lower borrowing costs for renewable energy compared to fossil fuels, leading to increased investment in renewables. Moreover, as CE policies become more stringent in a country, the probability of capital flowing into Oil & Gas or coal diminishes. In the electric utilities sector, we provide evidence that CE policies (solar & wind support policies) effectively attract more capital to renewable electric utilities.

Suggested Citation

  • Zhou, Xiao Yan & Caldecott, Ben & Shrimali, Gireesh & Zhang, Hanyu, 2025. "An empirical analysis of climate and environmental policy risk, the cost of debt and financial institutions' risk preferences," Energy Economics, Elsevier, vol. 144(C).
    • Handle: RePEc:eee:eneeco:v:144:y:2025:i:c:s014098832500146x
    DOI: 10.1016/j.eneco.2025.108323
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