Dynamic ESG Equilibrium

This paper develops and applies an equilibrium model that accounts for ESG demand and supply dynamics. In equilibrium, ESG preference shocks represent a novel risk source characterized by diminishing marginal utility and positive premium. Expected green asset returns are negatively associated with time-varying convenience yield, while positive exposure of unexpected returns to ESG preference shocks imply a positive green premium. Augmenting these conflicting forces with positive contemporaneous effects of preference shocks on realized returns, the green-minus-brown portfolio can deliver large positive payoffs for long horizons. Nonpecuniary benefits from ESG investing account for a nontrivial and increasing fraction of total consumption.

Keywords: ESG, Dynamic equilibrium, Asset pricing, Preference shock

JEL Classification: G12, G19, J71

Suggested Citation: Suggested Citation

Avramov, Doron and Lioui, Abraham and Liu, Yang and Tarelli, Andrea, Dynamic ESG Equilibrium (October 3, 2021). Available at SSRN: https://ssrn.com/abstract=3935174 or http://dx.doi.org/10.2139/ssrn.3935174