Abstract

We propose a theory in which each stock's environmental, social, and governance (ESG) score plays two roles: (1) providing information about firm fundamentals and (2) affecting investor preferences. The solution to the investor's portfolio problem is characterized by an ESG-efficient frontier, showing the highest attainable Sharpe ratio for each ESG level. The corresponding portfolios satisfy four-fund separation. Equilibrium asset prices are determined by an ESG-adjusted capital asset pricing model, showing when ESG raises or lowers the required return. Combining several large data sets, we compute the empirical ESG-efficient frontier and show the costs and benefits of responsible investing. Finally, we test our theory's predictions using proxies for E (carbon emissions), S, G, and overall ESG.

Keywords

Capital asset pricing modelSharpe ratioEfficient frontierPortfolioFrontierStock (firearms)Financial economicsCorporate governanceEconomicsAsset (computer security)BusinessEconometricsFinanceComputer science

Affiliated Institutions

Related Publications

Publication Info

Year
2020
Type
article
Volume
142
Issue
2
Pages
572-597
Citations
1580
Access
Closed

External Links

View on DOI.org

Social Impact

Altmetric
PlumX Metrics

Social media, news, blog, policy document mentions

Citation Metrics

1580
OpenAlex
1452
CrossRef

Cite This

Lasse Heje Pedersen, Shaun Fitzgibbons, Łukasz Pomorski (2020). Responsible investing: The ESG-efficient frontier. Journal of Financial Economics , 142 (2) , 572-597. https://doi.org/10.1016/j.jfineco.2020.11.001

Identifiers

DOI
10.1016/j.jfineco.2020.11.001

Data Quality

Data completeness: 77%