ESG Investing and Market Dynamics (Lecture Notes)

Vocabulary flashcards covering key terms and definitions from the ESG investing lecture notes, including investor types, market mechanisms, signals, MSCI scoring, and portfolio concepts.

ESG investor

An investor who considers environmental, social, and governance factors in investment decisions and may adjust portfolio composition to favor greener firms (represented by a fraction λ of the population).

Traditional investor

An investor who cares only about monetary returns and does not factor ESG attributes into decisions.

Market-clearing condition

Demand for stock from all investors equals supply; in the notes, sigmaESG + sigmaT = Sigma (total shares outstanding).

Sigma_ESG

Total number of shares demanded by ESG investors.

Sigma_T

Total number of shares demanded by traditional investors.

Sigma (total shares)

Total shares outstanding; the sum of demand from all investor types.

S0 (stock price at 0)

Stock price today; determined by market demand and supply (often treated as given in the setup).

S1 (stock price at 1)

Stock price in the next period; random realization influenced by cash flows and uncertainty.

D (cash flow per share)

Cash flow per share realized in period 1; a random variable representing per-share payoff.

Y (social externality)

The per-share social impact (ESG-related) with mean ybar and standard deviation sigma_y; independently distributed from D.

SD (cash-flow signal)

Signal on cash flow: SD = D + epsilon_d; the noisy publicly observed indicator of D.

SY (ESG rating signal)

Signal on social externality: SY = Y + epsilon_y; the noisy ESG-related observation.

Conditional expectation E[D | SD, SY]

The expected cash flow given observed signals SD and SY; used to inform investment decisions.

Signal-to-noise ratio (SNR)

A measure of signal precision: higher SNR means SD is a more accurate predictor of D (lower noise variance).

CRRA utility

Constant Relative Risk Aversion utility; a concave function used to model investor preferences with risk aversion parameter a.

Zeta_ESG

A parameter linking ESG holdings to ESG outcomes (e.g., ESG rating increases with more stock owned); governs how portfolio choice affects ESG score.

W0^I (initial wealth)

Initial wealth of investor type I (I = ESG or traditional); exogenously given.

C_T^ESG

Amount of wealth ESG investors allocate to the stock at time 0.

C_T^T

Amount of wealth traditional investors allocate to the stock at time 0.

E-score (MSCI firm-level)

MSCI firm-level environmental score; part of the ESG rating calculation.

E-weight (MSCI industry weight)

MSCI industry-level environmental weight; scales how important the industry is to society’s environmental goals.

G score (environmental rating)

MSCI-derived environmental component used to construct a final ESG score; industry-adjusted and typically negative before centering.

ICC (Implied Cost of Capital)

The forward-looking required return for a firm to attract capital, inferred from market prices.

Green portfolio vs Brown portfolio

A portfolio consisting of high-G (green) stocks versus low-G (brown) stocks, used to compare performance and risk premia.

Realized return

Actual return observed after the fact, calculated from price changes (no dividend assumed in the notes).

Expected return

Forward-looking return forecast based on risk, cash flows, and signals; can differ from realized return.