Green Sentiment, Stock Returns, and Corporate Behavior

How does investors' green appetite influence firms, and the market as a whole?

Willingness to pay for green products has been evolving, and mostly increasing, over the past few years. These changes are shaping financial markets, and are expected to only grow in influence in the years to come.

Marie Brière and Stefano Ramelli exploited an arbitrage mechanism on US ETF's primary market to estimate non-fundamental demand shock or green assets:

• They used the monthly abnormal excess flow into green ETFs compared to regular ones as a proxy for investors' appetite for responsible assets not already priced in the value of the underlying securities.
• Environmentally responsible firms benefit from a stock price out-performance when investors' green appetite is high.
• An increase of one standard deviation in investors' appetite can lead to an outperformance of 56 basis points 6 months later.
• The authors can predict stock prices variations with the same efficiency both before and after the Paris Agreements.
• When green sentiment is high, companies tend to make higher capital investments and keep more cash holdings.
• The authors integrated data from 2010 to 2020, which means the conclusions of their study are likely amplified today following the recent increase in popularity of "green" ETFs.

The question of the influence of green sentiment is critical for regulators, as it will likely be one of the main drivers of financial flows toward carbon emission reductions.

They also need to consider how higher green sentiment increases the financial strength and investment capacity of green firms, but may divert resources away from others still in transition or with environmental innovation potential.