Investment and Asset Pricing with ESG Disagreement

Abstract

This paper analyzes the equilibrium implications of ESG rating disagreement for portfolio decisions and asset pricing. Rating disagreement leads to higher effective risk aversion, higher market premium, and lower demand for stocks. Disagreement also tilts the negative ESG-CAPM alpha relation and affects the systematic risk exposure of individual stocks. Combining ESG ratings from six major rating agencies, we provide supporting evidence for the model predictions. Our findings help reconcile the mixed evidence on the cross-sectional return predictability of ESG ratings and they suggest that the lack of consistency in ESG ratings could distort the risk-return trade-off.

Keywords: ESG, Rating Disagreement, Effective Risk Aversion, Portfolio Choice, Capital Asset Pricing Model

JEL Classification: G11, G12, G24, M14, Q01