Stochastic Social Preferences and Corporate Investment Decisions

This paper develops a dynamic general equilibrium model with stochastic social preferences and endogenous corporate investment decisions. We find that firms’ investment decisions largely undo the effects of shifts in preferences on stock prices and risk premia. Only when most firms have already switched to a green technology do further preference changes have stronger effects on stock prices. Stochastic social preferences delay the move to a greener economy, especially when preference shocks correlate positively with aggregate cash flows. Risk aversion initially helps the transition, but later slows it down. Correlations between stock returns of firms in brown and green sectors increase (decrease) following an increase (decrease) in green investors’ social preferences. Small changes in social preferences can have large supply effects even when they only have negligible effects on the cost of capital wedge between green and brown firms.