Research | Lucie Y. Lu


Sustainable Investing Home and Abroad

We study how firm ESG performance affects domestic and foreign institutional investments. At the firm level, the marginal effects of ESG on institutional ownership vary across institution origin and investment destination countries. At the institution-firm level, institutions tilt towards high-ESG firms only when they are domestic. We term this asymmetry in ESG preference between domestic and foreign investment the “ESG home bias”. We explore ESG information environment, country E&S awareness, and ESG factor discount as potential economic mechanisms and find that the ESG home bias reflects a combination of these factors, the most important being information asymmetry about the ESG outcome measured by ESG uncertainty.

Institutional Investment and International Risk-sharing

We develop and estimate a new asset pricing model to study how global institutional investment affects global and local risk premia in 38 markets. By investing across countries, institutional investors facilitate international risk-sharing between home-biased retail investors. This risk-sharing channel depends on the scope of institutional investors’ mandate, their risk bearing capacity and substitutability between securities from different countries. Securities earn a global market risk premium as well as an institutional local risk premium. In addition, securities that are not invested by institutions earn a retail local risk premium. The average annual institutional local risk premium is 2.76% in developed markets and 6.27% in emerging markets. The average annual retail local risk premium is 1.71% in developed markets and 2.65% in emerging markets. Higher firm-level global institutional ownership reduces the cost of capital in emerging markets.

Default Linkages in a Structural Credit Model

We propose an explanation for default risk linkages based on a Lucas model with across independent debt-financed borrowers. The transmission mechanism is that variation in the size of a borrower impacts the default decision for all borrowers. If a negative shock hits one borrower’s fundamentals, the other borrower becomes a larger player in the economy and thus bears more systematic risk. The resulting higher risk premium increases the cost of debt and tilts that borrower’s decision towards default, thereby increasing its default risk and equity volatility. This effect is particularly strong for borrowers with greater rollover needs. Our model helps better understand co-movement in risk premia, default probabilities, and equity volatility across fundamentally-unrelated borrowers.

Who Invests in What? Public Firms Ownership Around the World

We construct a comprehensive database of public firm ownership in 49 countries and study the investment scope and preferences of different types of investors. Aggregate home bias has declined but is still much higher in emerging markets (EMs). Institutions have become more globally diversified but invest in a limited number of stocks. Retail investors remain highly home-biased. Institutions of different domiciles and types continue to show a strong preference for larger, more liquid, and more visible firms in both pooled regressions and country-level analyses but exhibit considerably heterogeneous preferences for other firm characteristics. Retail investors are mostly present in small and illiquid firms.