Project proposal summaries
The Impact Frontier
Jonathan Harris
Center for Sustainable Finance & Private Wealth; MIT Sloan School of Management
Part 1: Introducing the Impact Frontier - mostly completed work, lays basis for Part 2
Universal owners currently lack a quantitative tool to connect their portfolio allocation decisions to externalities. This proposal requests EIRN funding to deliver the final, publication-ready version of "The Impact Frontier," a new paper that provides such a tool. It introduces a versatile quantitative framework for modeling both the effect of externalities on portfolios and investor contribution to externalities.
The EIRN RFP notes that quantifying universal-ownership effects has lagged. My paper argues the challenge is deeper, especially when it comes to investor contribution: our core financial models must be rebuilt from first principles, because their standard assumptions—which treat firms as passive issuers of securities in frictionless markets with homogeneous investors—are incompatible with a serious treatment of externalities and investor contribution.
My paper meets that challenge by modeling capital markets as a system in which investors supply capital and firms demand it for real investment.While this may seem elementary, the model that results is dramatically different from conventional models. Some of the novel features of the model are of standard financial interest—for example it helps to explain the "factor zoo" found in the literature. But the most interesting features of the model are the implications when an externality is added to the model: this changes the optimal portfolio for any investor who cares about the externality, whether for fiduciary or altruistic reasons.
When calibrated on U.S. equity data, the model produces the first empirically-estimated "impact frontier". Heterogeneity in the supply and demand for different firms drives a significant wedge between this impact frontier and conventional ESG-efficient frontiers—so much so that typical ESG strategies can actually increase negative externalities. This empirical finding highlights the importance of such mathematical work for EIRN's core interests: without a robust framework, well-intentioned strategies can be counterproductive.
Figure 1: The impact frontier is the set of portfolios with the maximum (risk-adjusted) financial return for a given level of impact on the externality. The ESG-efficient frontier is the same but for the portfolio ESG score—when plotted in terms of investor impact it is necessarily below the impact frontier.
Part 2: Navigating the Impact Frontier: Optimal Investor Policies with Whole Portfolio Effects
Universal owners are uniquely exposed to the systemic risks generated by their own portfolios, yet financial models have largely failed to quantify this feedback loop. This project will develop a new paper that addresses this gap directly. Building on the framework of my "The Impact Frontier" proposal, this research will model how aggregate externalities affect firm profitability and risk, thereby allowing for the first time a quantitative estimate of the optimal position for a universal owner on the impact frontier.
I hypothesize that on small, local systems these effects will be significant, but for large-scale systems with diffuse ownership, like climate, the feedback for an individual, marginal investor will be modest. Thus, a key focus will be to move beyond this base case to quantify the strategic importance of two concepts that expand the set of "whole portfolio effects":
● Investor Coordination. Cooperative strategies among investors can significantly improve the shape of the impact frontier, providing a quantitative rationale for collaborative engagement and investor-led initiatives.
● Combinatorial Effects. Nonlinear effects, including threshold values and synergies, can dramatically alter the combined impact of a portfolio and hence the impact frontier and optimal policies. Finally, the framework will be used to explore policy robustness. Because the model's outputs can be complex and sensitive to input parameters, this research will analyze how universal owners can design investment policies that are resilient to uncertainty.
Together, this proposal forms a coherent research program with my "The Impact Frontier"
proposal. The latter establishes the foundational framework; this proposal builds on it to solve for the optimal investor strategy in the face of the complex, systemic effects that define the universal ownership challenge. It will provide the first complete quantitative toolkit for investors to optimize their portfolios accounting for important effects.
Figure 1: The framework in my "The Impact Frontier" proposal defines this curve. This proposal builds on this to determine the optimal position for an investor on the frontier—when the benefits of further investor impact on the externality become less than the marginal cost in risk-adjusted financial return.
Figure 2: Both cooperation and combinatorial effects can shift the impact frontier upwards, to the "advanced" impact frontier, making it rational for investors to pursue higher impact policies.
Double-Materiality Stress-Testing of Biodiversity Risk in Mutual-Fund Portfolios
Dr Maria Chiara Iannino, University of St Andrews
Dr Kulnicha Meechaiyo, University of St Andrews
Prof. Bert Scholtens, University of St Andrews and University of Groningen
Biodiversity loss has emerged as a systemic risk whose economic magnitude rivals that of climate change (World Economic Forum 2023). Previous literature about the environmental consequences of the business system has predominantly focused on risks arising from carbon-intensive sectors and, for example, reported that climate risks are highly concentrated. Furthermore, it shows that banks are highly concentrated on carbon-intensive corporate lending, which is expected to account for two-thirds of banks’ losses in transition risk (Baranović et al. 2022). So far, despite its systematic nature and importance, very little literature focuses though on biodiversity loss. The breadth of risk involved by irreversible nature loss might simultaneously and unpredictably affect a significant share of financial institutions across sectors and/or countries. It can then constitute a hard-to-diversify risk and provide scope for financial amplification and contagion. In particular, portfolio level evidence remains scant on both how nature risk hits performance and how funds’ capital flows shape biodiversity outcomes. Therefore, this project aims to integrate a double-materiality perspective into a rigorous quantitative approach to reveal whole-portfolio externalities deriving from biodiversity loss, providing three main contributions.
Current studies based on markets find an emergent biodiversity risk premium but coverage is limited to listed stocks, underestimating the systemic effect on universal owners. Moreover, existing “double materiality” work relies on static and contested ESG scores without combining inside-out (footprint) with outside-in (financial exposure) for the same asset. In our project, biodiversity degradation is treated both as an outside-in priced risk factor, that can erode returns, and as an inside out environmental impact generated by portfolio choices (Scholtens, 2017).
Left unpriced, the two channels interact to create a feedback loop that drags on long-horizon performance for universal owners. Using European and U.S. mutual-fund holdings (2005-2025), we will first quantify financial materiality by building a monthly Biodiversity (BIO) factor from company disclosures, ENCORE dependency scores, and satellite-observed nature loss. We will then estimate a multi-factor model to estimate the biodiversity factor, as β-BIO.
Secondly, the same asset holdings will be mapped to Global Forest Watch and WRI Aqueduct data to create fund-level biodiversity footprints in hectares of habitat loss and water stress. This will help identify systemic exposure and contribution to biodiversity risk of the universal owners. Factor-based tail metrics, such as system-wide loss, marginal systemic contribution and institution-level capital adequacy (Jung et al. 2025), will provide regulators and investors with a picture of biodiversity driven fragility. Then, a regime-switching structural Vector Autoregression (SVAR) and impulse-response analysis will endogenise fund performance and biodiversity footprints, and quantify the feedback loops over multiple horizons.
Finally, we will make use of regulatory shocks such as the 2021 Kunming Declaration, the EU Nature Restoration Law, and phased TNFD adoption of nature loss disclosure regulation to find out about fund sensitivity to these policy events. With staggered difference-in-difference estimators, we will test whether the deferent biodiversity regulations have reduced both footprints and system-wide risk, and under what conditions and fund characteristics. These evidence-based results of our project will inform decisions of both investors and policymakers.
The True Impact of Biomass Electricity Generation
Vaska Atta Darkua, Bucknell University
Ellen Quigley, University of Cambridge
In spite of an emerging consensus that woody biomass electricity generation is worse than coal in terms of biodiversity loss, emissions, and air pollution, the technology continues to receive substantial government subsidies worldwide and is typically classified by ESG reporting regimes as renewable energy with near-zero emissions. As evidence accumulates as to the harms to the environment and human health from woody biomass, regulation becomes more likely. Drawing from quantitative datasets across multiple subfields, this will be the first paper to (1) identify and quantify the various sources of financial, health, emissions, and biodiversity impacts associated with woody biomass electricity generation as well as (2) provide a methodology to estimate these adverse impacts both at a firm and portfolio level, including the total costs imposed respectively on diversified asset owners and on society, and (3) propose a new measure to inform universal owners of the scale and source of harm to their portfolios, allowing investors to compare systemic and idiosyncratic costs and offering valuable insights for policymakers, investors, and other stakeholders.
This will be the first paper to (1) identify and quantify the various sources of financial, health, emissions, and biodiversity impacts associated with woody biomass electricity generation as well as, (2) provide a methodology to estimate these adverse impacts both at a firm and portfolio level, including the total costs imposed respectively on diversified asset owners and on society, and (3) propose a new measure to inform universal owners of the scale and source of harm to their portfolios. Because this project aims to quantify harms at both the firm and portfolio level, the results should demonstrate to asset owners the difference between a systemic versus idiosyncratic approach to risk management.
By addressing these three key research questions, this paper seeks to provide a comprehensive analysis of the hidden costs and systemic risks associated with woody biomass electricity generation, offering valuable insights for policymakers, universal owners, and community stakeholders.