# Responsible Investing: The ESG-Efficient Frontier

**Authors:** Pedersen, Fitzgibbons, Pomorski
**Year:** 2019
**DOI:** 10.2139/ssrn.3466417
**URL:** https://doi.org/10.2139/ssrn.3466417

## Abstract

We propose a theory in which each stock’s environmental, social, and governance (ESG) score plays two roles: 1) providing information about firm fundamentals and 2) affecting investor preferences. The solution to the investor’s portfolio problem is characterized by an ESG-efficient frontier, showing the highest attainable Sharpe ratio for each ESG level. The corresponding portfolios satisfy four-fund separation. Equilibrium asset prices are determined by an ESG-adjusted capital asset pricing model, showing when ESG increases or lowers the required return. Combining several large data sets, we compute the empirical ESG-efficient frontier and show the costs and benefits of responsible investing. Finally, we test our theory’s predictions using commercial ESG measures, governance, sin stocks, and carbon emissions.

## Citation Details

Responsible Investing: The ESG-Efficient Frontier
**Authors**: Pedersen, Fitzgibbons, Pomorski
**Year**: 2019
**DOI**: 10.2139/ssrn.3466417
**URL**: https://doi.org/10.2139/ssrn.3466417

**Abstract**: We propose a theory in which each stock’s environmental, social, and governance (ESG) score plays two roles: 1) providing information about firm fundamentals and 2) affecting investor preferences. The solution to the investor’s portfolio problem is characterized by an ESG-efficient frontier, showing the highest attainable Sharpe ratio for each ESG level. The corresponding portfolios satisfy four-fund separation. Equilibrium asset prices are determined by an ESG-adjusted capital asset pricing model, showing when ESG increases or lowers the required return. Combining several large data sets, we compute the empirical ESG-efficient frontier and show the costs and benefits of responsible investing. Finally, we test our theory’s predictions using commercial ESG measures, governance, sin stocks, and carbon emissions.  # Truncate if very long

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