Hedging Ambiguity with Pro-Social Preferences: an Illustration from Green Finance

We explore how pro-social preferences interact with asymmetric ambiguity to influence investment decisions. We develop a model where financial returns are ambiguous (e.g., due to policy uncertainties), while social impact returns are risky or less ambiguous. Employing Gilboa-Schmeidler maxmin and Klibanoff-Marinacci-Mukerji smooth ambiguity frameworks, we demonstrate that pro-social motives act as a hedge, mitigating ambiguity aversion and reducing effective hurdle rates for ambiguous assets. This mechanism explains the resilience of impact investing in bridging environmental funding shortfalls and offers policy insights into how blended finance and standardization can convert ambiguity to risk. Distinct from prior work on blended finance structures, this study emphasizes the behavioral hedging role of social preferences in sustainable finance, with implications for accelerating just transitions amid polycrises.