Investor Behavior and Limitations of Asset Pricing Model under Green Finance

With the advancement of global sustainable development strategies, green finance has become a core driver of economic transformation and upgrading, and the development of environmental, social and governance (ESG) investment concepts has challenged traditional asset pricing models. Increasing investor attention to ESG factors has led to a shift in investment decision logic from single financial returns to multi-dimensional sustainability assessments. By combing the existing literature, this article discusses the transformation of investor behavior and the limitations of the CAPM and Fama French five-factor model in the context of green finance. The study shows that companies with good ESG performance receive higher market recognition and lower financing costs, while the CAPM model fails to fully explain asset returns because it does not incorporate ESG factors and investor sentiment. And although the Fama-French five-factor model has some explanatory power, it does not cover ESG dimensions, and some of the factors perform redundantly in the A-share market. However, after adding ESG factor, the performance of the model is improved, especially in the grouping of small capitalization and value stocks. Therefore, in the context of green finance, investor behavior presents ESG integration and sentiment-driven features, which challenge the validity of traditional pricing models.