Have shifts in investor tastes led the market portfolio to capture ESG preferences?

Based on the growing concern about ESG issues in financial markets, in this paper we implement a generalization of the model proposed by P ' astor, Stambaugh, and Taylor (2021), which predicts that when the market portfolio is not ESG-neutral and its greenness level increases, the market factor and the ESG factor become redundant, allowing the classic CAPM to account for ESG characteristics. Using market data series for the U.S. equity market, our results show that brown assets typically have negative ESG betas, the price of ESG risk is negative and progressively trends towards zero over time, and the explanatory power of the market portfolio on the ESG factor increases over time as the greenness level of the market portfolio improves. In any case, the period coinciding with the emergence of the COVID-19 pandemic implies a reversal of these trends. Our results suggest that efforts by public authorities to promote improvements in corporate ESG performance translate into lower cost of capital, especially in periods of overall declines in corporate ESG performance.