A Macro-Econometric Analysis of Asset Pricing, Carbon Risk Premium, and Volatility in U.S. Capital Markets

• Billy Elly

  Lautech

  Author

The intersection of federal climate policy and financial market stability has emerged as a critical area of inquiry following major U.S. banks' withdrawal from the Net-Zero Banking Alliance in 2024-2025, signaling a pronounced retreat from public climate commitments amid political and legal headwinds. This study addresses the gap in empirical evidence quantifying how green-banking mandates transmit through capital markets to affect asset pricing, carbon risk premiums, and volatility dynamics. Employing a macro-econometric framework combining multivariate GARCH models with time-varying connectedness analysis, we examine the transmission channels from green-banking policy shocks to U.S. equity, bond, and green financial markets over the period 2016-2025. Our analysis reveals that monetary policy tightening amplifies net outflow from brown bond markets by 2.3 percentage points within six months, while green equity markets exhibit a 73% reduction in volatility persistence following positive regulatory announcements. We identify a significant and time-varying carbon risk premium averaging 8.3% annually between green and brown equity portfolios, with the Green Minus Brown (GMB) factor demonstrating 89.4% explanatory power for cross-sectional return variation. The study provides a replicable framework for policymakers to assess the transmission mechanisms of climate-related financial regulations, with practical implications for bank capital adequacy frameworks and stress testing methodologies.

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Copyright (c) 2026 Billy Elly (Author)

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