Asset Prices and Portfolios with Externalities

Steven Baker, Burton Hollifield and Emilio Osambela
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Steven Baker: University of Virginia
Burton Hollifield: Carnegie Mellon University
Emilio Osambela: Board of Governors of the Federal Reserve System

No 1255, 2019 Meeting Papers from Society for Economic Dynamics

Abstract: Elementary portfolio theory implies that environmentalists optimally hold more shares of polluting firms than non-environmentalists, and that polluting firms are more highly valued and attract more investment than otherwise identical firms that do not pollute. These results reflect the demand to hedge against states with high pollution, occurring when dirty technology is more heavily and profitably utilized. Pigouvian taxation can reverse the valuation and investment results, but environmentalists will still overweight polluters in their portfolios. We introduce countervailing motives for environmentalists to underweight polluters, comparing the implications when environmentalists coordinate to internalize pollution, or have nonpecuniary disutility from holding polluter stock. With nonpecuniary disutility, introducing a green derivative product may dramatically alter who invests most in polluters, but has no impact on aggregate pollution.

Date: 2019
New Economics Papers: this item is included in nep-ene, nep-env and nep-res
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