Responsible Investing under Climate Change Uncertainty

We propose a theory of responsible investing under conditions of ambiguity induced by climate uncertainty in which a representative agent is ambiguity averse. This new theory delivers three novel insights. First, in our setting, the climate-related ambiguity perceived for asset returns is a strictly decreasing function of the environmental sustainability of the firm issuing the security. Second, we show the conditions under which ambiguity aversion endogenously lead to the expression of preferences that make an agent environmentally motivated. In particular, we show that in an economy with climate change uncertainty, environmentally motivated agents allocate their wealth according to a three-dimensional, mean-variance-ambiguity efficient frontier as well as to their attitudes towards risk and ambiguity, exactly as an ambiguity averse decision-maker would do. Third, we prove that the agents rationally select "green" portfolios in order to reduce their exposure towards ambiguity and maximize their ambiguity-adjusted Sharpe ratio. Our theoretical predictions are consistent with the empirical literature on the realized rewards-to-risks trade-off of responsible investing.