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Inclusion of ESG Ratings in Optimization

In: Advanced REIT Portfolio Optimization

Author

Listed:
  • W. Brent Lindquist

    (Texas Tech University)

  • Svetlozar T. Rachev

    (Texas Tech University)

  • Yuan Hu

    (University of California San Diego)

  • Abootaleb Shirvani

    (Kean University)

Abstract

ESG scores have become the tool to quantify the social responsiveness of asset issuing entities. This chapter develops the framework of ESG-valuation, under which the value of a traded asset is based upon both its financial and ESG components. The relative weighting of the two is controlled by an ESG affinity parameter. Beginning with the concept of an ESG-valued return, application of modern portfolio theory leads to optimization in a three-dimensional space defined by expected ESG-value, an associated risk measure, and ESG score. Efficient frontiers, capital market lines, risk-minimizing and tangent portfolios are definable in this space, leading to optimized, ESG-valued portfolios. This approach is applied to the domestic REIT portfolio using ESG-valued conditional value-at-risk and dynamic optimization. The behavior of its ESG-valued efficient frontiers and the tangent portfolios derived from them are studied as the value of the affinity parameter changes.

Suggested Citation

  • W. Brent Lindquist & Svetlozar T. Rachev & Yuan Hu & Abootaleb Shirvani, 2022. "Inclusion of ESG Ratings in Optimization," Dynamic Modeling and Econometrics in Economics and Finance, in: Advanced REIT Portfolio Optimization, chapter 0, pages 227-245, Springer.
    • Handle: RePEc:spr:dymchp:978-3-031-15286-3_13
    DOI: 10.1007/978-3-031-15286-3_13
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