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The Financial Performance of Socially Responsible Investments: Insights from the Intertemporal CAPM

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Abstract

This study formulates a two-factor empirical model under the intertemporal CAPM framework to evaluate the cross-sectional implications of socially responsible investments in the US equity market. Our results show that socially responsible investments have no asset pricing impact on the US market. We argue that this ‘no financial impact’ finding indicates that investors will not be disadvantaged financially by investing in socially responsible funds or corporations.

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Notes

  1. The ICAPM is a linear factor model of wealth (the market factor) and state variables (economic variables) that can explain the cross-sectional variation of asset returns (Cochrane, 2005). Such a framework has been widely adopted throughout the literature in explaining asset returns under an intertemporal economy (e.g. Chen et al. (1986); Campbell (1996); Vassalou (2003); Hsu and Huang (2010); Kim et al. (2011) and Kang et al. (2011)).

  2. SRI is a long-term investment approach that integrates environmental, social and governance (hereafter, ESG) considerations into the investment “decision-making” process (US SIF 2014 and Eurosif 2014).

  3. http://www.ussif.org/Files/Publications/SIF_Trends_14.F.ES.pdf (date accessed, 24/9/15).

  4. This approach is widely adopted in the asset pricing literature. See, for example, Fama and French (1992); Lettau and Ludvigson (2001) and Fama (2014).

  5. Examples of such variables are the aggregate dividend yield, term spread, default spread and short-term T-bill (Petkova 2006) and future GDP growth (Vassalou 2003).

  6. For instance, one of the potential long-term benefits of SRI relates to the development of new (e.g. environmentally friendly) technology, which ultimately creates long-term competitive advantages (Porter and Kramer, 2006).

  7. In this study, the costs and benefits are discussed to highlight that two opposing factors are at play with different time dimensions. We are not concerned with trying to empirically disentangle the costs and benefits—this is not of relevance in an asset pricing framework. Rather, the “net effect” of the two is what really matters and is our focus.

  8. Such an approach has been adopted by numerous recent ICAPM studies in capturing the unexpected components of a target variable, for instance, Vassalou (2003) and Kim et al. (2011).

  9. SRI mutual funds are commonly adopted in studies examining the financial impact of SRI. See, for example, Haigh and Hazelton (2004); Barnett and Salomon (2006); Benson et al. (2006) and Borgers et al. (2015).

  10. The KLD 400 Social index is also commonly employed in recent SRI studies. See for example, Harjoto and Jo (2011); Cai et al. (2012) and Giuli and Kostovetsky (2014).

  11. For examples of studies that use these performance metrics, see, Luther et al. (1992); Hamilton et al. (1993); Luther and Matatko (1994); Statman (2000); Derwall et al. (2005); Bauer et al. (2005); Bauer et al. (2006); Mill (2006); Bauer et al. (2007); Hill et al. (2007); Renneboog et al. (2008b) and Gil-Bazo et al. (2010).

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Correspondence to Philip Gharghori.

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Xiao, Y., Faff, R., Gharghori, P. et al. The Financial Performance of Socially Responsible Investments: Insights from the Intertemporal CAPM. J Bus Ethics 146, 353–364 (2017). https://doi.org/10.1007/s10551-015-2894-8

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  • DOI: https://doi.org/10.1007/s10551-015-2894-8

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