Stochastic ESG scores and nonpecuniary ESG preferences: An extension to CAPM

We propose an ESG-CAPM with stochastic ESG scores to address ESG score divergence and its uncertain impact on returns. Our model separates ESG utility from wealth, allowing ESG scores to adjust risk premia via market beta. Expected returns depend on both market and ESG betas, predicting higher returns when ESG betas exceed market betas. Investors demand higher returns for high ESG beta stocks, while greater weight on nonpecuniary utility lowers returns. Easily estimable, our model helps CFOs assess capital costs using CAPM-like methods and offers varied cost estimates based on different ESG rating agencies.