Pricing Sin Stocks: Ethical Preference vs. Risk Aversion

Project Start:06/2018
Researchers:Stefano Colonnello, Giuliano Curatola, Alessandro Gioffré
Category: Financial Markets
Funded by:LOEWE

Several empirical studies find that sin stocks (i.e., stocks of companies that are believed to make money from exploiting human weaknesses, such as alcohol, tobacco, and gambling companies) yield (on average) higher returns than those of non-sin comparable stocks. This so-called “sin premium” is often rationalized by a “boycott” risk factor, namely, the risk that socially responsible investors refuse to hold stocks of sin companies. As a result of the boycott strategy, sin companies are underpriced relative to non-sin companies and must promise higher returns to attract investors. This approach leaves some questions open.

First, according to the boycott approach, socially responsible investors always refuse to hold sin stocks, independently of their expected cash-flows. Therefore, the boycott-based approach leaves no room for a trade-off between ethicalness and cash-flows, even when the latter become more appealing. Second, the behavior of individual and institutional investors towards sin stocks may significantly differ. Institutional investors, such as mutual funds, pension funds, and foundations, may be subject to social pressures rising from their public exposure, and, accordingly, tend to be reluctant to hold stocks that conflict with their customers’ ethical principles. Individual investors, on the contrary, are generally free from transparency and accountability concerns and, consequently, may be more open to investing in any kind of stocks. Motivated by these considerations, we build a theoretical model intending to relax the boycott assumption. We assume that investors have preferences for gain opportunities (dividends) but weigh them according to their perception of firms’ responsible behavior (ethicalness). Investors do not necessarily boycott sin companies and are willing to receive dividends from both sin and non-sin stocks.


Related Published Papers

Author/sTitleYearProgram AreaKeywords
Stefano Colonnello, Giuliano Curatola, Alessandro GioffréPricing Sin Stocks: Ethical Preference vs. Risk Aversion
European Economic Review
2019 Financial Markets