Sustainable Investing with ESG Rating Uncertainty

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

Avramov, Doron and Cheng, Si and Lioui, Abraham and Tarelli, Andrea, Sustainable Investing with ESG Rating Uncertainty (July 26, 2021). Journal of Financial Economics (JFE), Vol. 145, No. 2, 2022, Available at SSRN: https://ssrn.com/abstract=3711218 or http://dx.doi.org/10.2139/ssrn.3711218