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Chasing the ESG factor

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  • Lioui, Abraham
  • Tarelli, Andrea

Abstract

We analytically compare two dominant methodologies for the construction of an ESG factor: the time-series (ratings used to sort stocks) and cross-sectional (ratings used to weight stocks) approaches. Differences in ESG rating and exposure to other firm characteristics imply an ex ante expected return spread between the two factors. We construct a cross-sectional factor (i) featuring a targeted rating, thus allowing comparability with other factors, (ii) neutralizing exposure to other firm characteristics, and (iii) not harming diversification through stock screening. Using ratings from several data vendors, we document strong variations of the factor alpha in the time series and across vendors. The conditional alpha is negatively related to the level of media attention for ESG and positively related to variations in media attention.

Suggested Citation

  • Lioui, Abraham & Tarelli, Andrea, 2022. "Chasing the ESG factor," Journal of Banking & Finance, Elsevier, vol. 139(C).
    • Handle: RePEc:eee:jbfina:v:139:y:2022:i:c:s0378426622000929
    DOI: 10.1016/j.jbankfin.2022.106498
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G19 - Financial Economics - - General Financial Markets - - - Other
    • J71 - Labor and Demographic Economics - - Labor Discrimination - - - Hiring and Firing

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