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A sustainability transition on the move? Evidence based on the disconnect from market fundamentals

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Abstract

In a context where European stock prices have been trending upwards, one of the main concerns is that stocks perceived as more sustainable from an environmental, social and governance (ESG) perspective could be particularly exposed to exuberance. To shed some light on the magnitude of the deviation of stock prices from fundamentals we apply a Markov-switching augmented version of the present-value model. Using monthly data on the European stock market from 2005 to 2022, our model suggests that at the beginning of 2022 the non-fundamental component was about one fourth of the total price. When looking at particular market segments, the model shows that green and ESG stocks behave broadly in line with the market. However, in recent years ESG stocks have shown a significant, though small, disconnect from the market. These finding suggest that investor preferences are shifting towards sustainability, while not posing immediate risks to market stability.

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  • Alessi, Lucia & Hirschbuhl, Dominik & Rossi, Alessandro, 2022. "A sustainability transition on the move? Evidence based on the disconnect from market fundamentals," Working Papers 2022-10, Joint Research Centre, European Commission.
    • Handle: RePEc:jrs:wpaper:202210
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    File URL: https://joint-research-centre.ec.europa.eu/publications/sustainability-transition-move-evidence-based-disconnect-market-fundamentals_en
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    Keywords

    Bayesian inference; European stock market; green transition; Markov-switching; present-value model;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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