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ESG as a conditional risk buffer: Idiosyncratic volatility and tail losses across market regimes

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  • Duong, An Thi Thuy

Abstract

This paper examines whether high ESG portfolios offer superior downside protection compared to low-ESG portfolios and the market conditions under which this advantage holds. Using annual ESG scores and daily U.S. stock returns (2018–2023), high- and low-ESG indices are constructed, and factor-neutral residual portfolios are derived after adjusting for Fama–French risk factors. A three-state Markov regime-switching model (MRSM) identifies low-, high-, and crash-volatility regimes, complemented by downside, Value-at-Risk (VaR), Conditional Value-at-Risk (CVaR), and Incremental CVaR (ICVaR) analyses. The results show that ESG integration enhances resilience but not returns: high-ESG portfolios display lower volatility and milder losses than low-ESG portfolios in non-crash regimes, while this advantage vanishes in crashes. Factor-neutral analysis attributes this resilience to reduced idiosyncratic risk rather than factor exposure. Downside and tail-risk measures further indicate that low-ESG portfolios amplify tail-risk. These results are robust to the battery of tests.

Suggested Citation

  • Duong, An Thi Thuy, 2026. "ESG as a conditional risk buffer: Idiosyncratic volatility and tail losses across market regimes," Finance Research Letters, Elsevier, vol. 92(C).
    • Handle: RePEc:eee:finlet:v:92:y:2026:i:c:s1544612326001194
    DOI: 10.1016/j.frl.2026.109588
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    References listed on IDEAS

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • Q56 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Environment and Development; Environment and Trade; Sustainability; Environmental Accounts and Accounting; Environmental Equity; Population Growth

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