Responsible investing: The ESG-efficient frontier

Lasse Pedersen, Shaun Fitzgibbons and Lukasz Pomorski

Journal of Financial Economics, 2021, vol. 142, issue 2, 572-597

Abstract: We propose a theory in which each stock's environmental, social, and governance (ESG) score plays two roles: (1) providing information about firm fundamentals and (2) affecting investor preferences. The solution to the investor's portfolio problem is characterized by an ESG-efficient frontier, showing the highest attainable Sharpe ratio for each ESG level. The corresponding portfolios satisfy four-fund separation. Equilibrium asset prices are determined by an ESG-adjusted capital asset pricing model, showing when ESG raises or lowers the required return. Combining several large data sets, we compute the empirical ESG-efficient frontier and show the costs and benefits of responsible investing. Finally, we test our theory's predictions using proxies for E (carbon emissions), S, G, and overall ESG.

Keywords: Portfolio choice; ESG; Socially responsible investing; Impact investing; Sustainable investing; CSR; Carbon; Governance (search for similar items in EconPapers)
JEL-codes: D62 G11 G12 G23 M14 Q5 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (276)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:142:y:2021:i:2:p:572-597

DOI: 10.1016/j.jfineco.2020.11.001

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