Monday, June 13, 2011

Socially Responsible Investing

Question and Answer with Fama and French.

Q: Are expected returns for "socially responsible" strategies lower compared to a conventional approach?

A:Our paper, "Disagreements, Tastes, and Asset Pricing," addresses this issue. Like all prices, asset prices are determined by supply and demand. If some investors overweight the stocks of "socially responsible" firms, they push up prices and reduce expected returns. Similarly, they push down the prices and push up the expected returns of the socially irresponsible firms they underweight. Presumably that is their goal—to reduce the cost of capital of firms they like by reducing the "good" firms' expected stock returns and to increase the cost of capital of firms they don't like by increasing the "bad" firms' expected stock returns. These changes in expected returns induce other investors to underweight the "good" firms and to overweight the "bad" firms. Socially responsible investing has not been around long enough to measure the magnitude of these effects. We can be sure, however, that if socially responsible investors have any real impact, they push down the expected return on the stocks they overweight and increase the expected return on the stocks they underweight.

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