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Sustainability and Asset Pricing: a Supply and Demand Approach
Subject
Asset Pricing
Date
2023
Motivation
Asset Pricing models comprise two fundamental elements: cash flows generated by firms (supply), and their valuation driven by investor preferences (demand). Firm sustainability has been shown to affect preferences, but it also impacts firms' cash flows. In this paper, I develop an Asset Pricing model that integrates supply and demand factors. Hence, it bridges the gap between preferences and the economic implications of firm sustainability, providing a more comprehensive and realistic framework for analyzing returns.
Abstract: Firm sustainability has been shown to affect asset prices through a demand-side channel stemming from investor preferences. In this paper, we derive an asset pricing model based on firm revenue and environmentally-driven cost-related risks. In equilibrium, returns do not only depend on the two revenue and cost individual risk factors, but also on a third factor that corresponds to the covariance between both sources of risks. Including investor tastes for green assets, the relationship between prices and sustainability can be studied through a joint supply and demand approach. Focusing on wage costs, we first test the supply-side factors using stock-level data and show that they carry significant premia in the cross-section. We then use the four factors to study the relationship between returns, wage costs and firm sustainability on the sample with available ESG data.