Investor Sentiment and the Time-varying Sustainability Premium
35 Pages Posted: 9 Jan 2020 Last revised: 16 Mar 2020
Date Written: November 28, 2019
Previous literature shows inconclusive results regarding the relation between the intensity of Corporate Social and Environmental Responsibility (CSR and CER) and expected returns. In this paper, we argue that the reason for these mixed results is that the sustainability premium, i.e., the return difference of high-intensity minus low-intensity CSR/CER firms, is time-varying and correlated with investor sentiment. Although the sustainability premium is indistinguishable from zero in the long-run, we find that high-intensity CSR (CER) firms have a monthly excess return, which is higher by 0.70 (0.88) monthly percentage points following periods of low investor sentiment as compared to periods of high investor sentiment. Given that standard pricing factors are not able to explain the mispricing caused by the level of investor sentiment on the sustainability premium, we propose a sustainability pricing factor, estimated as the second principal component of portfolios sorted on environmental and social variables, which explains this mispricing.
Keywords: sustainability, corporate social responsibility, corporate environmental responsibility, expected returns, financial performance, investor sentiment
JEL Classification: G12, G19, M41
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