Unraveling ESG Ambiguity, Price Reaction, and Trading Volume

Abstract

We introduce an asset pricing model that integrates investors’ ESG preferences and their ambiguous attitudes towards firms’ ESG performance, influenced by inconsistent ESG ratings from diverse rating agencies. Our model, considering unregulated ESG reporting and variations in agency assessments, reveals significant dynamics in asset pricing. We discover that stronger belief in high ESG scores among investors increases asset holdings and prices, whereas increased perceived ESG ambiguity negatively impacts these metrics. Crucially, the model demonstrates that the ESG ambiguity attitudes parameter and the degree of perceived ESG ambiguity are inversely related to asset prices. Specifically, we find that heightened perceived ESG ambiguity and a higher ESG ambiguity attitudes parameter are associated with lower asset prices, reflecting in increased trading volumes and widened price differentials. This research offers vital insights into how investors’ preferences and perceptions about ESG influence asset pricing.