Chasing the ESG Factor

77 Pages Posted: 8 Jul 2021 Last revised: 4 Nov 2021

See all articles by Abraham Lioui

Abraham Lioui

EDHEC Business School and Scientific Beta Research Chair

Andrea Tarelli

Catholic University of Milan

Date Written: July 1, 2021


We provide a new methodology for ESG factor construction. We analytically compare two dominant methodologies, the time-series (ESG ratings used as ordinal variable) and cross-sectional (ESG ratings used as cardinal variable) approaches. When the two factors have identical ratings and other firm characteristics are ignored, their expected returns are equal. This is no longer the case when other characteristics drive expected returns. We construct a cross-sectional factor (i) featuring a targeted rating, (ii) neutralizing exposure to other firm characteristics, being thus a pure ESG factor, and (iii) not harming diversification through stock screening. Using ratings from several ESG data vendors, we document strong variations of the factor alpha in the time series and across data vendors. The conditional alpha filtered from realized returns is negatively related to the level of an ESG sentiment variable based on media attention, while it is positively related to unexpected variations of ESG sentiment.

Keywords: ESG, Factor investing, Cross-sectional asset pricing, Sentiment

JEL Classification: G12, G19, J71

Suggested Citation

Lioui, Abraham and Tarelli, Andrea, Chasing the ESG Factor (July 1, 2021). Available at SSRN: or

Abraham Lioui (Contact Author)

EDHEC Business School and Scientific Beta Research Chair ( email )


Andrea Tarelli

Catholic University of Milan ( email )

Largo Gemelli, 1
Milan, 20123


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