Chasing the ESG Factor

76 Pages Posted: 8 Jul 2021 Last revised: 4 Apr 2022

See all articles by Abraham Lioui

Abraham Lioui

EDHEC Business School

Andrea Tarelli

Catholic University of Milan

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

Lioui, Abraham and Tarelli, Andrea, Chasing the ESG Factor (July 1, 2021). Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3878314 or http://dx.doi.org/10.2139/ssrn.3878314

Abraham Lioui (Contact Author)

EDHEC Business School ( 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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