Dynamic ESG Equilibrium

Forthcoming in Management Science

73 Pages Posted: 5 Oct 2021 Last revised: 7 Feb 2024

See all articles by Doron Avramov

Doron Avramov

Reichman University - Interdisciplinary Center (IDC) Herzliyah

Abraham Lioui

EDHEC Business School

Yang Liu

The University of Hong Kong - Faculty of Business and Economics

Andrea Tarelli

Catholic University of Milan

Date Written: October 3, 2021

Abstract

This paper proposes a conditional asset pricing model that integrates ESG demand and supply dynamics. Shocks in the demand for sustainable investing represent a novel risk source, characterized by diminishing marginal utility and positive premium. Green assets exhibit positive exposure to ESG demand shocks, hence commanding higher premia. Conversely, time-varying convenience yield leads to lower expected returns for green assets. Moreover, ESG demand shocks have positive contemporaneous effects on unexpected returns, contributing to large positive payoffs in the green-minus-brown portfolio over extended horizons. The model predictions align closely with evidence on return spreads between green and brown assets, further reinforcing the apparent gap between realized and expected spreads.

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

JEL Classification: G12, G19, J71

Suggested Citation

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

Doron Avramov

Reichman University - Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 4610101
Israel

HOME PAGE: http://faculty.idc.ac.il/davramov/

Abraham Lioui

EDHEC Business School ( email )

France

Yang Liu

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Andrea Tarelli (Contact Author)

Catholic University of Milan ( email )

Largo Gemelli, 1
Milan, 20123
Italy

HOME PAGE: http://sites.google.com/view/andreatarelli

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