Abstract

We model investing that considers environmental, social, and governance (ESG) criteria. In equilibrium, green assets have low expected returns because investors enjoy holding them and because green assets hedge climate risk. Green assets nevertheless outperform when positive shocks hit the ESG factor, which captures shifts in customers’ tastes for green products and investors’ tastes for green holdings. The ESG factor and the market portfolio price assets in a two-factor model. The ESG investment industry is largest when investors’ ESG preferences differ most. Sustainable investing produces positive social impact by making firms greener and by shifting real investment toward green firms.

Scientific Portfolio AI- Generated Summary

This paper explores the concept of sustainable investing and its potential impact on financial markets. The authors develop a model that incorporates environmental, social, and governance (ESG) factors into traditional financial analysis. They find that ESG factors can have a significant impact on asset prices and that investors who incorporate these factors into their investment decisions can earn higher returns.

The paper begins by presenting the authors’ baseline model, which considers a single period in which there are N firms. Each firm has an observable ESG characteristic, which can be positive (for “green” firms) or negative (for “brown” firms). The authors assume that firms produce social impact in addition to financial payoffs and that the return on each firm’s shares is normally distributed.

The authors then explore the quantitative implications of their model and find that ESG factors can have a significant impact on asset prices. They show that investors who incorporate these factors into their investment decisions can earn higher returns than those who do not. They also find that climate risk commands a premium, suggesting that investors are willing to pay more for assets that are less exposed to climate-related risks.

The paper concludes by examining the potential benefits and drawbacks of sustainable investing for investors and the broader economy. The authors argue that sustainable investing can lead to more efficient markets and better outcomes for society as a whole. However, they also note that there are challenges to implementing sustainable investing practices, including the lack of standardized ESG metrics and the potential for greenwashing.

Overall, this paper provides a valuable contribution to the growing literature on sustainable investing. The authors’ model provides a framework for incorporating ESG factors into traditional financial analysis, and their findings suggest that investors who do so can earn higher returns. While there are challenges to implementing sustainable investing practices, the authors argue that the potential benefits for investors and society as a whole make it a worthwhile endeavor.