Pure ESG?

Is it possible to isolate environmental, social and governance characteristics (ESG) effects on stock returns from those of other stock characteristics? In their July 2021 paper entitled “Chasing The ESG Factor”, Abraham Lioui and Andrea Tarelli specify a cross-sectional long-short ESG factor that neutralizes exposures to other firm characteristics, such as size and book-to-market ratio. By creating a pure ESG factor, they are able to isolate ESG alpha and estimate its separate E, S and G contributions. Their approach also suppresses effects of arbitrary ESG rating scales. They further construct an ESG sentiment index based on media attention to ESG-related topics and employ it to understand variations in pure ESG alpha. Using monthly firm ESG ratings from three sources as available during 1991-2019 and associated stock characteristics and returns during December 1992 through December 2020, with tests spanning December 2002 through December 2020, they find that: (more…)