Stochastic Social Preferences

We develop a dynamic general equilibrium model with stochastic social preferences and endogenous corporate investment in the green transition. Firms’ responses to changing investor tastes mitigate valuation effects of preference shocks occurring when investment is fixed. Thus, small changes in social preferences can have negligible cost-of-capital consequences, but large impact on corporate decisions. Our analysis shows that stochastic social preferences delay the transition, especially when preference shocks correlate positively with aggregate cash flows, and that they generate time-varying correlations between green and brown firms’ returns. While risk aversion initially accelerates the transition it impedes it later due to risk-sharing considerations.