ESG Investing: A Tale of Two Preferences
75 Pages Posted: 27 Apr 2022 Last revised: 18 Mar 2023
Date Written: March 28, 2022
What motivates ESG integration? I find both non-pecuniary and risk-mitigating preferences explain its prominence. Using widely endorsed ESG ratings, I show each preference induces sizable ESG 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 on ESG investing with non-pecuniary preference and reconciles mixed evidence in the empirical literature. In addition, I am able to identify the impact of investors’ hedging motives against negative non-pecuniary externalities via option-implied risk-neutral moments.
Keywords: Environmental, Social, Governance (ESG) investing, Non-pecuniary preference, ESG equity premia, Option-implied moments, Externalities.
JEL Classification: G11, G12, G13, G41, M14
Suggested Citation: Suggested Citation