Sustainable Investing with ESG Rating Uncertainty
65 Pages Posted: 14 Oct 2020 Last revised: 28 Jul 2021
Date Written: July 26, 2021
This paper analyzes the asset pricing and portfolio implications of an important barrier to sustainable investing---uncertainty about the corporate ESG profile. In equilibrium, the market premium increases and demand for stocks declines under ESG uncertainty. In addition, the CAPM alpha and effective beta both rise with ESG uncertainty and the negative ESG-alpha relation weakens. Employing the standard deviation of ESG ratings from six major providers as a proxy for ESG uncertainty, we provide supporting evidence for the model predictions. Our findings help reconcile the mixed evidence on the cross-sectional ESG-alpha relation and suggest that ESG uncertainty affects the risk-return trade-off, social impact, and economic welfare.
Keywords: ESG, Rating Uncertainty, Portfolio Choice, Capital Asset Pricing Model
JEL Classification: G11, G12, G24, M14, Q01
Suggested Citation: Suggested Citation