Econometric Modeling of Equity Volatility and Capital Costs Surrounding Regulatory Reclassifications of Sustainable Funds

• Abi cit

  Lautech

  Author

Regulatory reclassifications of sustainable funds under the SEC's amended Names Rule and the EU's SFDR have created significant uncertainty regarding the stability and pricing implications of sustainability labels. Existing literature has examined fund flows and ESG ratings, yet no validated econometric framework exists that models the joint dynamics of equity volatility and cost of capital surrounding these regulatory events. This study develops a hybrid GARCH-MLR framework integrating EGARCH volatility estimation with structural break detection to model the financial impact of fund reclassifications. Using panel data from 343 sustainable funds subject to the amended Names Rule and 230 European funds affected by SFDR Level 2 reclassifications, the analysis employs event-based regressions with interaction terms for ESG status, regulatory exposure, and fund characteristics. The proposed framework demonstrates 89.4% predictive accuracy for identifying volatility spikes within a 30-day event window, substantially outperforming static GARCH baselines (73.2%) and linear regression models (68.7%). Key findings reveal that funds retaining sustainable labels exhibit 18.3% lower post-reclassification volatility and a 42-basis-point reduction in implied cost of equity compared to relabeling funds. The framework provides a replicable tool for portfolio managers, fund administrators, and regulators to assess reclassification risk and optimize capital cost management during sustainability label transitions.

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