Responsible Investing: The ESG-efficient Frontier

Lasse Heje Pedersen*, Shaun Fitzgibbons, Lukasz Pomorski

*Corresponding author for this work

Research output: Contribution to journalJournal articleResearchpeer-review


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 raises 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 proxies for E (carbon emissions), S, G, and overall ESG.
Original languageEnglish
JournalJournal of Financial Economics
Number of pages26
Publication statusPublished - 9 Nov 2020

Bibliographical note

Epub ahead of print. Published online: 9 November 2020.


  • Portfolio choice
  • ESG
  • Socially responsible investing
  • Impact investing
  • Sustainable investing
  • CSR
  • Carbon
  • Governance

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