ESG Risk Exposure: A Tale of Two Tails

Abstract

Investing in ESG assets has now become the rule of thumb whenever investors want risk
shield, especially during the COVID period. Since ESG investments are evidenced to have
lower downside risk, how and to which extent the downside risk of a company is affected by
its ESG activities is of particular interest to investors and regulators. This paper studies the
ESG impact to the downside risk of companies in the US market by introducing a novel
measure, the ESG risk contribution (△CoESGRisk). △CoESGRisk is a measurement based
on the co-movement between the ESG risk factor (the realization of ESG activities in the
market) and the downside risk. We show that when there is a sudden increase in the ESG risk factor, the downside risk of high-ESG companies is reduced. However, under extreme conditions, the downside risk of high-ESG companies could also be increased. The ESG impact is positively correlated with the ESG performance and company size, and it varies among different sectors. Our paper provides investors with a new method for ESG risk management. For regulators, our new
measurement offers some references on evaluating the impact of ESG-related policies through
quantifying the ESG risk contribution.

Keywords: ESG, ESG Risk Factor, Fama/MacBeth Risk Factor, Quantile Regression, CoVaR, ESG Sentiment

JEL Classification: G12, G32, C51