Responsible investing: The ESG-efficient frontier

By Lasse Heje Pedersen, Shaun Fitzgibbons, Lukasz Pomorski. Journal of Financial Economics, 2020

1,401 citations recorded by the source corpus.

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 increases 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 commercial ESG measures, governance, sin stocks, and carbon emissions.

Subfields: Accounting, Finance, Strategy and Management

View Paper: https://www.semanticscholar.org/paper/9a456c68d84fe247e053add2ed0b08e80ba9c34a

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Citations in the corpus

Corporate Social Responsibility and Sustainable Finance (2020, neutral): “In the Pedersen et al. (2020) model, the investor’s asset allocation problem is reduced to a tradeoff between ESG and the risk-adjusted return.”
Past, present, and future of sustainable finance: insights from big data analytics through machine learning of scholarly research (2022, positive): “…evaluation criteria (Chatzitheodorou et al., 2019), with studies showing better performance of socially responsible funds over traditional funds (Pedersen et al., 2020), higher market-to-book ratios and higher return on assets for socially responsible investors (Dam & Scholtens, 2015), and an…”
Firms and social responsibility: A review of ESG and CSR research in corporate finance (2021, background): “Similarly, Pedersen, Fitzgibbons, and Pomorski (2020) explicitly assume that investors have ESG/CSR preferences in their utility functions and in a different approach assume there exist three types of investors in the economy, those wanting green stocks, those wanting brown stocks and those that…”