When Ethics Clash with Cash: The Sin Stock Dilemma

Abstract

In this thesis, we study the performance of sin stocks in the European market over the period from 2004 to 2024. Sin stocks are defined as equities of companies operating in traditionally controversial industries, specifically alcohol, tobacco, and gambling. We also extend our analysis to include weapon and defence stocks, motivated by their paradoxical role in profiting from conflict while serving national security interests, a dynamic highlighted by the Russia-Ukraine war. To analyse the performance of sin stocks, we employ time-series regressions using CAPM and Fama-French factor models. We examine both excess returns over the risk-free rate and implement a long-short strategy comparing sin stocks against their industry comparables.

Our findings demonstrate that European sin stocks have historically generated statistically significant abnormal returns over the period from 2004 to 2024. This suggests that investors holding sin stock portfolios have been compensated with returns exceeding those predicted by traditional asset pricing models. While sin stocks achieved higher cumulative returns than their comparable companies over the period, this outperformance is not statistically significant after adjusting for risk factors. These results imply that socially responsible investors could have replicated the strong returns of sin stocks by exposing their portfolio to certain risk factors. Ultimately, our findings suggest that investors do not need to compromise their ethical standards to achieve strong returns, as the return differential cannot be attributed to a distinct "sin premium".

In this thesis, we study the performance of sin stocks in the European market over the period from 2004 to 2024. Sin stocks are defined as equities of companies operating in traditionally controversial industries, specifically alcohol, tobacco, and gambling. We also extend our analysis to include weapon and defence stocks, motivated by their paradoxical role in profiting from conflict while serving national security interests, a dynamic highlighted by the Russia-Ukraine war. To analyse the performance of sin stocks, we employ time-series regressions using CAPM and Fama-French factor models. We examine both excess returns over the risk-free rate and implement a long-short strategy comparing sin stocks against their industry comparables.

Our findings demonstrate that European sin stocks have historically generated statistically significant abnormal returns over the period from 2004 to 2024. This suggests that investors holding sin stock portfolios have been compensated with returns exceeding those predicted by traditional asset pricing models. While sin stocks achieved higher cumulative returns than their comparable companies over the period, this outperformance is not statistically significant after adjusting for risk factors. These results imply that socially responsible investors could have replicated the strong returns of sin stocks by exposing their portfolio to certain risk factors. Ultimately, our findings suggest that investors do not need to compromise their ethical standards to achieve strong returns, as the return differential cannot be attributed to a distinct "sin premium".