Unraveling the Trade-off between Sustainability and Returns: A Multivariate Utility Analysis

TL;DR

This paper develops a multivariate utility model for ESG investors, deriving optimal asset allocations and showing that investors can increase green investments without sacrificing financial satisfaction, supported by empirical analysis of US stocks from 2010-2020.

Contribution

It introduces a closed-form multivariate utility framework for ESG investing, allowing preference modeling and demonstrating increased green allocations without reducing financial satisfaction.

Findings

Investors can increase green investments without lowering pecuniary satisfaction.

High ESG-rated stocks attract more wealth allocation among ESG-sensitive investors.

Empirical data shows increased investment in high-rated ESG stocks over time.

Abstract

This paper proposes an expected multivariate utility analysis for ESG investors in which green stocks, brown stocks, and a market index are modeled in a one-factor, CAPM-type structure. This setting allows investors to accommodate their preferences for green investments according to proper risk aversion levels. We find closed-form solutions for optimal allocations, wealth and value functions. As by-products, we first demonstrate that investors do not need to reduce their pecuniary satisfaction in order to increase green investments. Secondly, we propose a parameterization to capture investors' preferences for green assets over brown or market assets, independent of performance. The paper uses the RepRisk Rating of U.S. stocks from 2010 to 2020 to select companies that are representative of various ESG ratings. Our empirical analysis reveals drastic increases in wealth allocation toward high-rated ESG stocks for ESG-sensitive investors; this holds even as the overall level of pecuniary satisfaction is kept unchanged.