Investor Demand and Sustainable Investments

I analyze risk and return dynamics of sustainable investments with a focus on investor demand. I find that demand for green stocks in comparison with brown stocks is higher and led by active institutional investors especially during the last quinquennium. Predictive regressions show that one standard deviation increase in ESG ratings leads to an increase of 0.3% in the ownership of a stock by active institutional investors in the next quarter. I empirically confirm the theoretical proposition of Pastor et al. (2021) that heightened demand for green stocks leads to better performance of green assets over brown assets. Portfolio analysis and firm level Fama-Macbeth regressions show that green stocks perform better than brown stocks during the period of heightened demand from active institutional investors. Controlling for this demand quashes the performance of green stocks over brown stocks