Asset Pricing and Sustainability: A Teaching Note

Abstract

In the transition to a sustainable economy, companies are increasingly adopting the goal of long-term value creation, which integrates financial, social and environmental value. However, investors struggle to invest for long-term value creation and perform the social function of finance. Conventional investment approaches, based on the neo-classical paradigm of portfolio theory and efficient markets, only capture financial value in their financial risk and return space. Attempts at sustainability integration through environmental, social and governance (ESG) ratings are typically too shallow to overcome this problem.

This teaching note presents an alternative investment paradigm, based on adaptive markets and fundamental analysis, that is better able to pursue long-term value creation. This long-term investment approach includes active management that assesses companies’ transition preparedness, concentrated portfolios, and deep engagement.

This teaching note can be used in courses on asset pricing. It complements asset pricing textbooks, which usually adopt the capital asset pricing model.

Keywords: asset pricing; capital asset pricing model; ESG factors; active investing; engagement

JEL Classification: G11, G12, G14