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Cited by 2,103Corporate Social Responsibility ReportingSustainable Finance and Green BondsFinancial Markets and Investment Strategies

Responsible investing: The ESG-efficient frontier

Open access
Pedersen, Lasse Heje, Fitzgibbons, Shaun, Pomorski, Lukasz·2021·Journal of Financial Economics
DOI 10.1016/j.jfineco.2020.11.001
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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.

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  • As the fraction of ESG investors grows, green firms can raise capital at a lower cost and enjoy high valuation, forcing brown firms to become green and green firms to become greener.

    “Thus, as the fraction of ESG investors grows, green firms can raise capital at a lower cost and enjoy high valuation, forcing brown firms to become green and green firms to become greener.”

    From A review on ESG investing: Investors' expectations, beliefs and perceptions (2024) · cites this paper as Pedersen et al., 2021

    Section 3.1 (page not supplied) says greater adoption of ESG investing raises high-ESG stock prices and that high-ESG firms have a lower cost of capital. It also says the paper does not explicitly model firms’ decisions to invest in ESG. The claim that this forces brown firms to become green and green firms to become greener therefore goes beyond the source. (LLM, conf=0.88)

    Experimental — accuracy not yet measured

  • According to Pedersen et al. (2021), the relative performance of ESG investments is conditioned on the type of investors that is prevalent in the market.

    “According to Pedersen et al. (2021), the relative performance of ESG investments is conditioned on the type of investors that is prevalent in the market.”

    From A review on ESG investing: Investors' expectations, beliefs and perceptions (2024) · cites this paper as Pedersen et al. (2021)

  • In the short run, ESG investments can outperform non-ESG investments through various channels.

    “However, in the short run, ESG investments can outperform non-ESG investments through various channels.”

    From A review on ESG investing: Investors' expectations, beliefs and perceptions (2024) · cites this paper as Pedersen et al. (2021)

  • Pedersen, Fitzgibbons, and Pomorski (2021) is one example of a theory with both value and values ESG investors.

    “Pedersen, Fitzgibbons, and Pomorski (2021) is one example of a theory with both value and values ESG investors.”

    From Presidential Address: Sustainable Finance and ESG Issues— <i>Value</i> versus <i>Values</i> (2023) · cites this paper as Pedersen, Fitzgibbons, and Pomorski (2021)

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Cites

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Research works printed but not linked: 19

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Cited by

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Authors
Pedersen, L. H., Fitzgibbons, S., & Pomorski, L.
Affiliations
Copenhagen Business School (DK)
Corresponding author
Pedersen, Lasse Heje
ORCID
Pedersen, Lasse Heje
Venue
Journal of Financial Economics
Publisher
Elsevier BV
Published
2021-11
Volume
142
Issue
2
Pages
572-597
ISSN
0304-405X (ISSN-L)
DOI
10.1016/j.jfineco.2020.11.001
OpenAlex
W3125969230
Cited by
2,103
References
4
Citations by year
2026: 398 · 2025: 509 · 2024: 472 · 2023: 341 · 2022: 247 · 2021: 79 · 2020: 35 · 2019: 15 · 2018: 3 · 2017: 1 · 2012: 1
FWCI
144.63
Type
journal article
Language
en
Open access
Licence
Locations
  • Journal of Financial Economics (publishedVersion, cc-by-nc-nd)
  • SSRN Electronic Journal (publishedVersion)
  • CBS Research Portal (Copenhagen Business School) (publishedVersion, cc-by-nc-nd)
  • RePEc: Research Papers in Economics (submittedVersion)
  • CBS Research Portal (Copenhagen Business School) (submittedVersion, other-oa)
Topics
  • Social Sciences › Business, Management and Accounting › Strategy and Management › Corporate Social Responsibility Reporting
  • Social Sciences › Economics, Econometrics and Finance › Finance › Sustainable Finance and Green Bonds
  • Social Sciences › Economics, Econometrics and Finance › Finance › Financial Markets and Investment Strategies
Keywords
responsible investing, ESG ratings, portfolio optimization, Sharpe ratio, investor preferences, equilibrium asset pricing, CO2 emissions, firm fundamentals

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