Regulatory Uncertainty: Asset Allocation and Asset Pricing

Regulatory uncertainty is a central channel through which policy affects financial decisions. We develop a programmatic conceptual framework for studying regulatory uncertainty in asset allocation and asset pricing. We define regulatory uncertainty as uncertainty about the design, timing, implementation, interpretation, and enforcement of regulations that directly shape cash flows, feasible actions, institutional constraints, and market expectations. This perspective distinguishes regulatory uncertainty from broader economic policy uncertainty by focusing on regulations, regulatory parameters, and enforcement practices rather than on policy uncertainty in general. The framework identifies four main entry points into financial models: cash-flow dynamics, beliefs and learning, regulatory constraints including tax constraints, and intermediary capital and liquidity constraints. It also clarifies when regulatory uncertainty is merely reflected in expected cash flows and when it commands a risk premium. We illustrate the framework in selected domains in which regulatory uncertainty is economically important: financial regulation, climate policy, taxation, and insurance. We thereby provide a common language for connecting theoretical modeling, measurement, and empirical analysis of regulatory uncertainty and for deriving implications for investors, firms, intermediaries, and regulators.