Welfare Consequences of Sustainable Finance.

This article develops a dynamic stochastic general-equilibrium model to analyze the welfare effects of sustainable finance mandates that require investors to hold firms meeting net-zero carbon emissions targets. Firms qualify as sustainable by investing in decarbonization capital, which reduces their required rate of return—termed the "greenium"—reflecting the dividend yield forgone to mitigate climate risks. The model incorporates climate tipping points and weather disaster shocks, showing that mandates can substantially improve welfare by incentivizing decarbonization, thereby lowering aggregate climate risks and supporting economic growth. However, the mandated market economy alone does not achieve the first-best outcome due to investment distortions; introducing an additional investment tax on deviations from average investment restores first-best efficiency. Quantitative analysis calibrated to empirical data demonstrates that welfare-maximizing mandates closely approximate the first-best solution, with transition dynamics sensitive to adjustment costs of decarbonization capital. The findings provide a theoretical foundation for sustainable finance mandates as a policy tool to address climate externalities while highlighting the importance of complementary instruments to fully align private incentives with social welfare.