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Journal of Financial Economics Vol. 145 No. 2 2022

Sustainable investing with ESG rating uncertainty

Doron Avramov1; Si Cheng2; Abraham Lioui3; Andrea Tarelli4

1 Reichman University · 2 Chinese University of Hong Kong · 3 Ecole des Hautes Etudes Commerciales du Nord · 4 University of Milan

Abstract

This paper analyzes the asset pricing and portfolio implications of an important barrier to sustainable investing: uncertainty about the corporate ESG profile. In equilibrium, the market premium increases and demand for stocks declines under ESG uncertainty. In addition, the CAPM alpha and effective beta both rise with ESG uncertainty and the negative ESG-alpha relation weakens. Employing the standard deviation of ESG ratings from six major providers as a proxy for ESG uncertainty, we provide supporting evidence for the model predictions. Our findings help reconcile the mixed evidence on the cross-sectional ESG-alpha relation and suggest that ESG uncertainty affects the risk-return trade-off, social impact, and economic welfare.

DOI
10.1016/j.jfineco.2021.09.009
Volume
145
Issue
2
Pages
642-664
Language
en
Sources
crossref bibtex:phds-export.bib openalex

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