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

ArXiv ID: 2307.12161 “View on arXiv”

Authors: Unknown

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.

Keywords: ESG Investing, CAPM, Multivariate Utility Analysis, RepRisk Rating, Green Stocks, Equities

Complexity vs Empirical Score

  • Math Complexity: 8.0/10
  • Empirical Rigor: 5.0/10
  • Quadrant: Holy Grail
  • Why: The paper uses advanced continuous-time stochastic calculus with a multi-attribute utility function and CAPM structure, requiring dense mathematical derivations, yet it also incorporates a decade of real-world U.S. stock data for empirical validation.
  flowchart TD
    A["Research Goal: Impact of ESG Preferences <br> on Portfolio Allocation"] --> B["Methodology: Multivariate Utility Analysis"]
    B --> C["Model: CAPM-type structure with <br> Green Stocks, Brown Stocks, Market Index"]
    C --> D["Data: RepRisk Rating U.S. Stocks 2010-2020"]
    D --> E["Computational Process: Closed-form solutions for <br> optimal allocations and value functions"]
    E --> F["Outcome 1: No loss in wealth required <br> to increase green investments"]
    E --> G["Outcome 2: Increased allocation to <br> high-ESG stocks for sensitive investors"]