Sustainable investing with ESG ambiguous information

Abstract

This study introduces a novel model that incorporates ambiguous ESG information into the asset pricing framework, examining its impact on the optimal demand, equilibrium expected excess return, and welfare of an investor. Our analysis reveals that an investor’s response to insights into ESG performance significantly depends on the nature of the information received. When confronted with negative ESG information and lower excess return, the investor opts for high-precision information, resulting in a lower optimal asset demand with a steeper growth slope in demand. Conversely, with higher excess return, the investor chooses low-precision information, leading to a higher optimal asset demand with a gentler slope of demand growth. Furthermore, we identify a unique “ESG excess return region” where the investor’s optimal demand remains unchanged despite ambiguous ESG information. Moreover, the study finds that asset yield a higher equilibrium expected excess return with high-precision ESG signals than with low-precision signals when the ESG information is negative. Lastly, the research explores investor welfare, indicating that the welfare under positive information is significantly higher than under negative information. This study sheds light on the subtle strategies that an investor employs when facing uncertainties related to ESG information.