Lorenzo Garlappi's webpage

Responsible Consumption, Product Substitutability,
and Asset Prices

Abstract:
We develop a model in which responsible consumers’ preferences are transmitted to asset prices through product markets. Product substitutability governs the hedging properties of green and brown stocks. When products are hard to substitute, price adjustments buffer adverse quantity shocks, making green stocks effective consumption hedges that earn lower expected returns. When products are substitutable, this buffer weakens, green returns move closely with quantities, and green stocks earn higher expected returns. The green premium therefore increases monotonically with product substitutability, a cross-sectional pattern that investor “warm-glow” preferences and regulatory risk cannot produce. In U.S. data, the annual green premium rises from −3.6% for low-substitutability portfolios to +6.0% for high-substitutability portfolios, a 9.6 percentage point difference robust to standard risk controls. Structural estimation of the model attributes this pattern primarily to responsible consumption, while finding at most a minor role for warm-glow investment preferences.