Market-based environmental regulation and equity risk pricing: Evidence from China's SO2 emissions trading pilot

Does market-based environmental regulation affect the equity return investors require from regulated firms? This study addresses this question using China’s 2007 SO 2 emissions trading pilot as a quasi-experimental policy setting. Using A-share listed firms in SO 2 -emitting industries from 2003 to 2023, we estimate a difference-in-differences model that compares firms in pilot and non-pilot provinces before and after policy implementation. The baseline results show that the pilot significantly reduces firms’ cost of equity capital, indicating that the policy is associated with a lower required equity return as reflected in . The effect emerges gradually after implementation and remains robust to alternative cost-of-equity measures, alternative policy timing, alternative inference procedures, province-level placebo assignments, an expanded-sample triple-difference specification, entropy-balanced DID estimation, and regional-condition adjustments. Channel tests show that the pilot is associated with lower analyst forecast dispersion and lower idiosyncratic volatility. These patterns are consistent with two parallel financial channels: reduced information uncertainty and lower firm-level risk exposure. Heterogeneity analyses further show that the decline in the cost of equity capital is stronger among firms with greater pre-policy information opacity and risk exposure, in regions with stricter environmental enforcement, and among non-state-owned enterprises. By combining established cost-of-capital, information-risk, and idiosyncratic-risk measures in a unified policy-evaluation framework, this study provides evidence on how a conventional pollutant-rights trading policy is reflected in capital-market pricing in an emerging economy.