Water as an Investment and the Impact of Regulatory Risk

ABSTRACT Water is a fundamental commodity. However, China is ranked as one of the top countries in terms of water scarcity. Hence, the country urgently needs large investment in its water sector. In this paper, we investigate the impact of regulatory risk on water investments guided by the ‘buffering effect theory’ and with the application of the Kalman filter and panel regression within the context ofthe Capital Asset Pricing Model. The question of utmost importance here is whether regulatory decisions affect systematic risk of water companies traded on the Chinese stock market. In other words, the effect of regulatory intervention measures may be moderated by investors’ perception of the overall political environment. We find a significantly negative effect of competition which suggests that when a regulator takes steps to reduce market competition, water companies are likely to gain greater power on the market resulting, in turn, in higher price levels and profit margins. The findings of this study contribute to the understanding of how investors can be attracted to participate in the water industry, not just in China, but also worldwide.