The impact of green investors on stock prices

(September 2023, revised March 2024)

Summary

Focus

We study the impact of green investors on stock prices in a dynamic equilibrium asset-pricing model, with three types of investor: green, passive or active. Green investors track an index that exludes progressively the firms with the highest greenhouse gas emissions. Active investors maximise expected returns and can buy the stocks of brown firms. Passive investors stick to a market capitalisation-based index.

Contribution

We find a large fall in the stock prices of the brownest firms, which are excluded by investors. In turn, the stock prices of greener firms increase when the exclusion strategy is announced and during the transition process. The immediate and large effects at the announcement date yield a first-mover advantage to the green investors who adopt the decarbonisation strategy at an early stage. This price impact comes from the imperfect substitution of stocks.

Findings

In our baseline calibration, where the market is composed of 30% green investors, 50% passive indexers and 20% active investors, we find that the stock price of the brownest firms, excluded one year after the exclusion strategy is announced, would drop by 6.9% upon announcement. The price drop would reach 5.6% ten years after the announcement, which is when the exclusion process is completed. In contrast, the price of the greener firms that remain in the market index would increase by 1%. The cost of capital of the brownest firms would increase by 20 basis points as compared with that of greener ones. The smaller the fraction of active investors relative to green investors, the stronger the price impact of green investment. Moreover, this adverse price effect would be amplified if larger systemic climate shocks were to materialise, further encouraging the early adoption of green investment.

Abstract

We study the impact of green investors on stock prices in a dynamic equilibrium model where investors are green, passive or active. Green investors track an index that progressively excludes the stocks of the brownest firms, passive investors hold a value-weighted index of all stocks, and active investors hold a mean-variance efficient portfolio. Contrary to the literature, we find large drops i n the stock prices of the brownest firms and moderate increases for greener firms. These effects occur primarily upon the announcement of the green index's formation and continue during the exclusion process. The announcement effects imply a first-mover advantage to early adopters of decarbonisation strategies.

JEL classification: G12, G23, Q54

Keywords: asset pricing, green investing, passive investing, portfolio rebalancing