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Dynamic ESG Equilibrium

Author

Listed:
  • Doron Avramov

    (Arison School of Business, Reichman University (IDC Herzliya), 4610101 Herzliya, Israel)

  • Abraham Lioui

    (Department of Finance, EDHEC Business School, 06200 Nice, France)

  • Yang Liu

    (HKU Business School, University of Hong Kong, Hong Kong, China)

  • Andrea Tarelli

    (Department of Mathematics for Economic, Financial and Actuarial Sciences, Catholic University of Milan, 20123 Milan, Italy)

Abstract

This paper proposes a conditional asset pricing model that integrates environmental, social, and governance (ESG) demand and supply dynamics. Shocks in the demand for sustainable investing represent a novel risk source, characterized by diminishing marginal utility and positive premium. Green assets exhibit positive exposure to ESG demand shocks, hence commanding higher premia. Conversely, time-varying convenience yield leads to lower expected returns for green assets. Moreover, ESG demand shocks have positive contemporaneous effects on unexpected returns, contributing to large positive payoffs in the green-minus-brown portfolio over extended horizons. The model predictions align closely with evidence on return spreads between green and brown assets, further reinforcing the apparent gap between realized and expected spreads.

Suggested Citation

  • Doron Avramov & Abraham Lioui & Yang Liu & Andrea Tarelli, 2025. "Dynamic ESG Equilibrium," Management Science, INFORMS, vol. 71(4), pages 2867-2889, April.
    • Handle: RePEc:inm:ormnsc:v:71:y:2025:i:4:p:2867-2889
    DOI: 10.1287/mnsc.2022.03491
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