Investors require compensation for the risk they assume when investing in stocks, known as the equity risk premium. Financial research has long examined how wars, geopolitical tensions, and uncertainty surrounding climate policies affect stock market performance.
An analysis by Corrado Botta, published in Economics Letters, shows that these risks, when considered individually, do not significantly explain the equity risk premium. Their effect emerges instead through their interactions and the financial environment in which the shocks occur.
The findings capture a defining feature of today’s economic and financial landscape. Crises rarely occur in isolation: a geopolitical shock can influence energy prices, reshape the debate over climate policy, and spill over into financial conditions. Considering each risk separately may therefore lead to an underestimation of the actual exposure of firms and financial markets.
Geopolitics and climate policy uncertainty
The article analyzes the returns of 49 U.S. stock market industry portfolios, constructed according to the Fama-French classification, over 431 months, from January 1990 to January 2026, for a total of more than 21,000 observations. The research question is whether non-financial risks help explain stock returns in excess of the risk-free rate after controlling for the five Fama-French factors.
The author considers three dimensions. The first two are non-financial: geopolitical risk, measured using the Caldara and Iacoviello (2022) index, and climate policy uncertainty, measured using the Gavriilidis et al. (2026) index. The third dimension concerns the state of the financial system, measured through the Federal Reserve Bank of Chicago’s National Financial Conditions Index.
None of the three variables, taken individually, has a substantial effect on the returns of the industries examined. This conclusion differs from earlier research, which documents separate risk premiums associated with both geopolitical risk and carbon-related risk.
The picture changes when three interaction terms are considered: geopolitical risk and climate policy uncertainty, climate policy uncertainty and financial stress, and geopolitical risk and financial stress.
- The interaction between geopolitical risk and climate policy uncertainty has a positive effect on the equity risk premium. When these two sources of instability occur simultaneously, investors demand higher returns to hold equities.
- Even more important is the interaction between climate policy uncertainty and financial stress. When the financial system is already under pressure, an increase in regulatory uncertainty surrounding climate policy depresses returns.
- The interaction between geopolitical risk and financial stress also affects returns, but in the opposite direction. When financial conditions are already tight, a geopolitical shock of similar magnitude increases the return required by investors.
The magnitude of the climate-finance channel is particularly significant. In the 17 industries classified as exposed to the climate transition—including oil, coal, utilities, chemicals, steel, mining, transportation, construction, and agriculture—the effect is nearly four times larger than the estimate for the remaining industries.
Climate policy uncertainty therefore represents the main point of intersection between geopolitical risk and financial risk, as well as one of the channels through which different sources of instability are transmitted to equity markets.
Pay attention to policy timing
For investors and portfolio managers, the study suggests that monitoring geopolitical risk, climate-related risk, and financial conditions separately may underestimate overall exposure. Incorporating the interactions among these factors into valuation models can help estimate sector-specific risk more accurately and build more resilient portfolios.
The findings also offer useful insights for policymakers. The cost of regulatory ambiguity on climate issues is not constant over time but depends on the condition of the financial system. When financial conditions are already tight, an ill-defined regulatory framework amplifies market vulnerability and disproportionately penalizes the sectors expected to support investment in the transition.
The timing of a policy announcement and the level of detail with which it is defined are therefore not neutral with respect to their impact on financial markets.
Finally, the research opens a broader avenue for future work. The same approach can be extended to other combinations of risks, other markets, and other asset classes. More generally, the study suggests that finance must adapt its analytical tools to an economy in which crises do not simply follow one another but increasingly overlap and reinforce each other.
Corrado Botta, “Do non-financial risks compound? Evidence from U.S. industry returns.”
Economics Letters, Volume 268, 2026, 113158. DOI: https://doi.org/10.1016/j.econlet.2026.113158.
