How do investors' ESG preferences influence market dynamics?
In « Sustainable Investing in Equilibrium », Luboš Pástor, Robert F. Stambaugh, and Lucian A. Taylor propose a market model explicitly integrating financial actors' ESG concerns.
Their equilibrium model features many heterogeneous firms and agents with varying preferences for sustainability. Their conclusions include:
- Investors' preferences for sustainability influence asset prices, investment portfolios, the size of the ESG investment industry, and the social impact of investing.
- Relevant input factors include firms' ESG characteristics and agents' utility from holding green assets, their concern for firms' aggregate social impact, and their level of concern for climate risk.
- Green assets have lower expected returns in equilibrium due to investors' preference for holding them and their role in hedging climate risk.
- Green assets outperform when the « ESG factor » capturing shifts in customers' and investors' preferences towards green products experiences positive shocks.
- The ESG investment industry reaches its largest size when investors' ESG preferences are most dispersed. The larger the industry, the larger the shift of real investment towards green firms.
- Sustainable investing leads to positive social impacts by encouraging firms to adopt greener practices and reallocating capital towards firms that have a positive environmental impact.
This study provides a theoretical foundation of the dynamics of sustainable investing and its implications on asset prices, investment strategies, and corporate behaviour.
Critics may argue for empirical validation of the model's predictions, particularly regarding the magnitude of the ESG factor's impact on asset prices and the real-world effectiveness of sustainable investing in driving corporate behaviour change.