Asset Prices and Portfolios with Externalities

Abstract

Elementary portfolio theory implies that environmentalists optimally hold more shares of polluting firms than non-environmentalists, and that polluting firms are more highly valued and attract more investment than otherwise identical firms that do not pollute. These results reflect the demand to hedge against states with high pollution, occurring when dirty technology is more heavily and profitably utilized. Pigouvian taxation can reverse the valuation and investment results, but environmentalists will still overweight polluters in their portfolios. We introduce countervailing motives for environmentalists to underweight polluters, comparing the implications when environmentalists coordinate to internalize pollution, or have nonpecuniary disutility from holding polluter stock. With nonpecuniary disutility, introducing a green derivative product may dramatically alter who invests most in polluters, but has no impact on aggregate pollution. * We thank Aytek Malkhozov, Edward Van Wesep, and participants at various seminars and conferences for comments.

Understanding Macro and Asset Price Dynamics During the Climate Transition

“…Therefore, fossil fuel rms and dirty rms respond negatively to good climate policy shocks (and positively to bad, tax-reducing climate policy shocks), such that their climate policy risk premia are negative. This result is in line with the intuition provided by Baker, Hollield, and Osambela (2019) and Roth Tran (2019) that dirty rms paradoxically provide a hedge against the consequences of climate change.…”

“…Taking this together with the response of the stochastic discount factor, we obtain positive climate policy risk premia for the clean sector and negative climate policy risk premia for the dirty sector. This result, which implies that climate policy risk premia dampen the devaluation of dirty and oil rms rather than amplifying it, is in line with the intuition provided by Baker, Hollield, and Osambela (2019) and Roth Tran (2019) that dirty rms paradoxically provide a hedge against the consequences of climate change.…”

“…Relatedly, Ilhan, Sautner, and Vilkov (2018) show that dirty rms exhibit increased downside risk as measured from out-of-the-money put options. Baker, Hollield, and Osambela (2019) develop a portfolio allocation model with externalities, clean and dirty stocks, and households that are dierently exposed to climate change.…”

Fiscal Policies for a Low-Carbon Economy

“…In particular, carbon taxation decreases the costs of green bonds and leads to lower volatility for green investments (Heine et al, 2019;Gevorkyan et al, 2017). In practice, pricing mechanism effects can also be amplified by coordination efforts between economic agents to internalize pollution as well as nonmonetary disutility from holding polluter stock (Baker et al, 2019).…”

Pricing sin stocks: Ethical preference vs. risk aversion

“…Similarly, Baker, Hollifield, and Osambela (2018) consider a framework where investors choose between ethical (i.e., non-polluting) and unethical (i.e., polluting) firms.…”