The optimism premium: Repricing climate risk through adaptation policy

To address the limited understanding of how climate change uncertainty affects capital market pricing mechanisms, particularly through government-led adaptation policies, this study examines whether and how China's Sponge Cities Pilot (SCP) policy influences analysts' earnings forecast optimism. The results show that, following the implementation of the SCP policy, the proportion of analysts issuing optimistic earnings forecasts for firms located in pilot cities increases by 0.003 relative to non-pilot cities, representing approximately 50% of the sample mean. This effect is attributed by mitigating firms' business risk and inspiring analysts' catering behavior. Further analyses indicate that the positive effect of the SCP policy on analysts' forecast optimism is more pronounced for non-state-owned enterprises and firms operating in high competitive industries. More importantly, analysts with less work experience are more likely to issue optimistically biased earnings forecasts for firms located in SCP cities, whereas more experienced analysts tend to adopt a more conservative stance, reflecting greater caution in interpreting policy-induced signals. Overall, these findings highlight that climate adaptation policies can reshape market expectations through both risk mitigation and signaling channels, thereby contributing to the literature on climate change uncertainty pricing in financial markets.