Dynamic ESG Equilibrium

Doron Avramov, Abraham Lioui, Yang Liu, Andrea Tarelli*

*Corresponding author

Research output: Contribution to journalArticlepeer-review

Abstract

This paper proposes a conditional asset pricing model that integrates environmental, social, and governance (ESG) demand and supply dynamics. Shocks in the demand for sustainable investing represent a novel risk source, characterized by diminishing marginal utility and positive premium. Green assets exhibit positive exposure to ESG demand shocks, hence commanding higher premia. Conversely, time-varying convenience yield leads to lower expected returns for green assets. Moreover, ESG demand shocks have positive contemporaneous effects on unexpected returns, contributing to large positive payoffs in the green-minus-brown portfolio over extended horizons. The model predictions align closely with evidence on return spreads between green and brown assets, further reinforcing the apparent gap between realized and expected spreads.
Original languageEnglish
Pages (from-to)1-23
Number of pages23
JournalManagement Science
DOIs
Publication statusPublished - 2024

Keywords

  • ESG
  • preference shock
  • asset pricing
  • dynamic equilibrium

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