The impact of regulation on risk and return

Abstract

In this paper, we analyze the impact of regulation of firms on their stock performance. Based on the notion that regulation protects existing firms from new market entries, we firstly outline a transmission channel which leads to higher-than-expected stock returns and lower volatility as long as a firm stays regulated. However, these benefits come at the cost of substantial performance losses and an increasing volatility in case the firm gets deregulated. Thus, the superior performance in terms of return and risk before a potential deregulation can be seen as a premium for the deregulation risk. Based on a new dataset from QuantGov which quantifies industry-specific regulation in the US, we present empirical evidence for the outlined effects during an observation period from 2000 to 2020; i.e., regulation increases return and reduces risk, but deregulation imposes severe losses.