Sustainable Investing with ESG Rating Uncertainty

51 Pages Posted: 14 Oct 2020 Last revised: 9 Feb 2021

See all articles by Doron Avramov

Doron Avramov

Interdisciplinary Center (IDC) Herzliyah

Si Cheng

Chinese University of Hong Kong - Department of Finance

Abraham Lioui

EDHEC Business School and Scientific Beta Research Chair

Andrea Tarelli

Catholic University of Milan

Date Written: February 8, 2021

Abstract

This paper analyzes the asset pricing and portfolio implications of an important barrier to sustainable investing—uncertainty about the corporate ESG profile. In equilibrium, ESG uncertainty increases risk aversion and market premium and decreases demand for stocks. ESG uncertainty also tilts the negative ESG-CAPM alpha relation and affects individual stocks' systematic risk exposures. Employing the standard deviation of ESG ratings from six major providers as a proxy for ESG uncertainty, we provide evidence supporting the model predictions. Our findings help reconcile the mixed evidence on the cross-sectional ESG-alpha relation and suggest that ESG uncertainty could distort the risk-return trade-off.

Keywords: ESG, Rating Uncertainty, Effective Risk Aversion, Portfolio Choice, Capital Asset Pricing Model

JEL Classification: G11, G12, G24, M14, Q01

Suggested Citation

Avramov, Doron and Cheng, Si and Lioui, Abraham and Tarelli, Andrea, Sustainable Investing with ESG Rating Uncertainty (February 8, 2021). Available at SSRN: https://ssrn.com/abstract=3711218 or http://dx.doi.org/10.2139/ssrn.3711218

Doron Avramov

Interdisciplinary Center (IDC) Herzliyah ( email )

P.O. Box 167
Herzliya, 46150
Israel

Si Cheng (Contact Author)

Chinese University of Hong Kong - Department of Finance ( email )

12/F, Cheng Yu Tung Building
No.12, Chak Cheung Street
Shatin, N.T.
Hong Kong

HOME PAGE: http://www.bschool.cuhk.edu.hk/staff/cheng-si/

Abraham Lioui

EDHEC Business School and Scientific Beta Research Chair ( email )

France

Andrea Tarelli

Catholic University of Milan ( email )

Largo Gemelli, 1
Milan, 20123
Italy

HOME PAGE: http://sites.google.com/view/andreatarelli

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