Sustainable Investing: Empirical Tests
Lubos Pastor, Charles P. McQuaid Professor of Finance
In a recent paper, titled, "Sustainable investing in equilibrium", joint with Luke Taylor and Rob Stambaugh, we developed a theoretical equilibrium model of sustainable investing. This paper, which we presented on April 10, 2020 at the first virtual NBER Asset Pricing meeting, currently has a "Revise and resubmit" status at the Journal of Financial Economics. The model developed in the paper makes numerous empirical predictions that we would like to test empirically in future work.
Our main interest in testing the model's predictions related ot the relative performance of "green" and "brown" stocks (i.e. stocks of firms with high and low environmental, social, and governance (ESG) ratings, respectively). For example, our model predicts that green stocks should underperform brown ones in the long run. However, the model also predicts that green and brown stocks have opposite exposures to an ESG risk factor, which captures unexpected shifts in ESG tastes of customers and investors. If either kind of ESG tastes strengthen unexpectedly over a given period of time, green stocks can outperform brown stocks over that period. In addition, under certain conditions, stocks are priced by a two-factor asset pricing model, where the factors are the market portfolio and the ESG factor. Besides these predictions about performance, the model presented in our paper makes a number of additional predictions that we would like to examine as well. More generally, we plan to do more empirical work on sustainable investing and this dataset would be very helpful to us in that effort.
Dissecting green returns, with Robert F. Stambaugh and Lucian A. Taylor, 2022. Journal of Financial Economics 146, 403--424.