The drivers of the relationship between corporate environmental performance and stock market returns

Is there a relationship between corporate environmental performance (CEP) and stock returns? And if so, what drives this relationship: changes in corporate risk exposure or mispricing because of investors' taste for high CEP stocks, based on personal values or social norms? To answer these questions, we use a new and comprehensive ranking that measures the environmental performance of the 500 largest publicly traded US corporations. Our methodology is based on the Fama–French–Carhart four-factor asset-pricing model. In addition, we incorporate a fifth factor to capture common CEP-related risks. The results point to a negative relationship between CEP and stock returns, partially driven by common CEP-related risks. At the same time though, the influence of taste cannot be ruled out.