Download This PaperESG Confusion and Stock Returns: Tackling the Problem of Noise
71 Pages Posted: 12 Oct 2021 Last revised: 24 May 2024
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ESG Confusion and Stock Returns: Tackling the Problem of Noise
ESG Confusion and Stock Returns: Tackling the Problem of Noise
Date Written: October 12, 2021
Abstract
Existing measures of ESG (environmental, social, and governance) performance -- ESG ratings -- are noisy and, therefore, standard regression estimates of the effect of ESG performance on stock returns are biased. Addressing this as a classical errors-in-variables problem, we develop a noise-correction procedure in which we instrument ESG ratings with ratings of other ESG rating agencies. With this procedure, the median increase in the regression coefficients is a factor of 2.1. The results are similar when we use accounting profitability measures as outcome variables. In simulations, our noise-correction procedure outperforms alternative approaches such as simple averages or principal component analysis.
Keywords: measurement error, instrumental variables, sustainable investing, ESG ratings
JEL Classification: C26, G12, Q56
Suggested Citation: Suggested Citation
Florian Berg
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
100 Main Street
Cambridge, MA 02142
United States
Swiss Finance Institute ( email )
c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland
Roberto Rigobon
Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )
E52-447
Cambridge, MA 02142
United States
617-258-8374 (Phone)
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