Dynamic carbon emissions and liquidity management under policy transition risks

Liquidity is central to long-run green innovation under policy transition risk. We develop a dynamic model of carbon emissions and liquidity management for financially constrained firms under carbon policy transition risk. Our results show that greater policy transition risk promotes green innovation when cash liquidity is abundant, but reduces it when constrained. Furthermore, our paper reveals an inverted U-shaped relationship between policy stringency and green innovation. Moderate policy stringency promotes green innovation as the innovation-benefit effect dominates, whereas excessive stringency strengthens the liquidity-cost effect and discourages innovation by tightening firms' liquidity constraints. This finding provides theoretical support for the Porter Hypothesis and offers a potential explanation for the conflicting empirical evidence on the relationship between green innovation and environmental regulation.