Socially responsible investment in an environmental overlapping generations model

One of the problems associated with the conservation of the environment is that short-lived individuals fail to account for the long-term effects of pollution, which implies that future generations bear the costs imposed by the current generation. Such intergenerational externalities are usually tackled by (Pigovian) taxes, fiscal policy or environmental regulation. Alternatively, we propose that socially responsible investment funds create a role for the stock market to deal with intergenerational environmental externalities. We analyze the role of the stock market in an environmental overlapping generations model of the Diamond-type, in which agents choose between investing in "clean" government bonds or "polluting" firm equity. We show that although socially responsible investors are short-lived, the forward-looking nature of stock prices can help to resolve the conflict between current and future generations. (C) 2010 Elsevier B.V. All rights reserved