ESG as Protection against Downside Risk
Center for Financial Studies Working Paper No. 708, 2023
56 Pages Posted: 26 Jan 2023 Last revised: 13 Apr 2023
Date Written: January 23, 2023
We examine whether the uncertainty related to environmental, social, and governance (ESG) regulation developments is reflected in asset prices. We proxy the sensitivity of firms to ESG regulation uncertainty by the disparity across the components of their ESG ratings. Firms with high ESG disparity have a higher option-implied cost of protection against downside tail risk. The impact of the misalignment across the different dimensions of the ESG score is distinct from that of ESG score level itself. Aggregate downside risk bears a negative price for firms with low ESG disparity.
Keywords: ESG, rating, downside risk, options, regulation, risk premium
JEL Classification: G12, G18, G32
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