Chasing the ESG Factor
76 Pages Posted: 8 Jul 2021 Last revised: 4 Apr 2022
Date Written: July 1, 2021
Abstract
We analytically compare two dominant methodologies for the construction of an ESG factor: the time-series (ratings used to sort stocks) and cross-sectional (ratings used to weight stocks) approaches. Differences in ESG rating and exposure to other firm characteristics imply an \textit{ex ante} expected return spread between the two factors. We construct a cross-sectional factor (i) featuring a targeted rating, thus allowing comparability with other factors, (ii) neutralizing exposure to other firm characteristics, and (iii) not harming diversification through stock screening. Using ratings from several data vendors, we document strong variations of the factor alpha in the time series and across vendors. The conditional alpha is negatively related to the level of media attention for ESG and positively related to variations in media attention.
Keywords: ESG, Factor investing, Cross-sectional asset pricing, Media attention
JEL Classification: G12, G19, J71
Suggested Citation: Suggested Citation