ESG Investing: A Tale of Two Preferences

Kenan Institute of Private Enterprise Research Paper No. 4069015

85 Pages Posted: 27 Apr 2022 Last revised: 15 Aug 2023

See all articles by Paul Yoo

Paul Yoo

Kogod School of Business - American University

Date Written: March 28, 2022

Abstract

What motivates ESG integration? I find both non-pecuniary and risk-mitigating preferences explain its prominence. A novel test based on changes in mutual funds’ portfolio holdings and several empirical findings establish the two widely endorsed ESG ratings proxy these preferences. With this, I show each preference induces sizable equity premium identified through option-implied expected returns. Due to unexpectedly persistent demand growth for ESG-conscious assets, realized returns mask true ESG pricing effects, especially those attributable to non-pecuniary preference. Consequently, this paper lends support to recent theoretical frameworks with non-pecuniary preference and explains why empirical literature has lacked consensus.

Keywords: Environmental, Social, Governance (ESG) investing, Non-pecuniary preference, ESG equity premia, Externalities, Option-implied moments.

JEL Classification: G11, G12, G13, G41, M14

Suggested Citation

Yoo, Paul, ESG Investing: A Tale of Two Preferences (March 28, 2022). Kenan Institute of Private Enterprise Research Paper No. 4069015, Available at SSRN: https://ssrn.com/abstract=4069015 or http://dx.doi.org/10.2139/ssrn.4069015

Paul Yoo (Contact Author)

Kogod School of Business - American University ( email )

4400 Massachusetts Avenue NW
Washington, DC 20816-8044
United States

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