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Sustainable investing in equilibrium

Sustainable investing in equilibrium

10-06-2020 | From the field
This is a theoretical paper which investigates what happens if some investors care about ESG, while others do not, or care less. The authors 1 show that, in equilibrium, green assets have negative alphas, while brown assets have positive alphas.
  • David Blitz
    David
    Blitz
    Head of Quant Research

The ESG investment industry is at its largest, and the alphas of ESG-motivated investors are at their lowest, when there is large dispersion in investors’ ESG preferences. When this dispersion shrinks, so does the ESG industry. If all investors care equally much about ESG, they all end up holding the market portfolio.

In other words, a dispersion in ESG preferences is necessary for an ESG investment industry to exist. The results in this paper are consistent with previous studies that treat ESG integration as merely a constraint. This ignores the possibility that stocks with strong ESG characteristics may be underpriced, and have positive expected alphas as a result of this mispricing.

1 Pastor, L., Stambaugh, R. F., Taylor, A. T., 2020, “Sustainable Investing in Equilibrium”, Journal of Financial Economics, Forthcoming.
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