FV-89 | Sustainable Finance and Investor Sentiment

Prof. O. Mahmoud, Dr. D. Ballinari

Corporate Finance

Research Topic
Sustainable finance refers to any form of financial service that has a potentially positive impact on sustainable development. It is the response of the discipline of financial economics to global challenges faced by humanity and an acknowledgment of the need for interdisciplinary efforts. In 2006, the United Nations established its Principles of Responsible Investment (UN PRI) in collaboration with the investment industry, governments, and representatives of the public, thus committing themselves to integrating sustainability issues into their investment decision making and choosing so-called sustainable investments (SI).

While sustainable investing is not a new construct, its availability has increased over recent years to meet prevailing market demand. Regulators, institutional investors, and in particular retail traders no longer exclusively consider trade-offs between risk and return when making investment decisions: environmental, social, and governance criteria (ESG) have become an important part of their decision-making process. The increasing interest and demand for socially responsible investments are of particular interest in the asset pricing literature. The behavior of investors is a central component in the formation of asset prices as well as for the formation and propagation of risk in financial markets. This project aims to develop a deep understanding of how sentiment for sustainable investing is developing in the financial market and its implication on asset pricing.

Statement of the Problem
There is mounting evidence both in academic research and in practitioner and media writings that sentiment for sustainability is increasing in financial markets.

As of today, a real-time measure of investors’ “taste” for sustainability is still missing. Thus far, the empirical evidence of its implications for asset prices is mainly based on experiments and small-scale surveys. Capturing in a timely fashion the sentiment for sustainability is of central importance to understanding its implications, not only for the financial market but also for individuals, society, and policymakers.

This raises two important questions, which we aim to answer in this project:

(i) How can we objectively, quantitatively, and exhaustively measure market

sentiment for sustainability?

(ii) What are the economic implications, in particular in terms of asset

pricing, of the increasing sentiment for sustainability?


Given the main goal of understanding investor sentiment towards sustainable finance, our objectives are twofold. First, we aim to capture the market sentiment for sustainability by using text mining and sentiment analysis algorithms to extract information about investors’ mood from relevant sources of textual data, such as social networks, media platforms, etc. A thread of publications in financial and behavioral economics reports a significant influence of such news analytics on the behavior of stock prices. More precisely, using state-of-the-art textual analysis tools, we plan to build direct measures of investors’ sustainability perception.

In a second step, using this new and direct measure of investor sentiment for sustainability, we plan to investigate its implications on asset prices. Indeed, a large share of the overall movement of an individual stock (regardless of its sustainability criteria) has been attributed to market sentiment, and we aim to understand whether sustainability sentiment does indeed have an effect on the risk and return characteristics of stocks and whether this relationship between sentiment and asset prices is dependent on volatility regimes.


Importance, Usefulness, and Novelty of the Project
So far, although there is some evidence that sentiment for sustainable finance is gaining momentum in the market, this evidence is either based on small-scale surveys and experiments, or on anecdotal non-peer-reviewed evidence of practitioners. Both the academic financial economics community as well as practitioners are still missing a quantitative real-time measure to grasp the market’s perception of sustainability.

One of our main contributions is to incorporate sophisticated quantitative methodologies analyzing large amounts of data and news analytics into the thus-far mostly qualitative measures of sentiment in the universe of sustainable finance. Our new sentiment measure is expected to represent the market as a whole rather than a small subset of a group of individual investors.

In particular, the use of social media activities allows us to construct a real-time measure of society’s and investors’ awareness of a company’s social responsibility. This new measure has several advantages compared to classical sustainability ratings. First, it directly captures people’s “taste” for sustainability. Secondly, it allows for changes in society’s perception of what is sustainable. Third, while classical ESG ratings are usually reported at a monthly frequency, this new approach allows us to measure sustainability in a more timely fashion.

More importantly, this new measure allows for a proper analysis of the economic implications of changes in sentiment for sustainability. In particular, our results will not only shed light on the implications that sustainable investments have on the return and risk of assets but also serve as a major building block for future research in this field.