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Environmental, Social and Governance-Valued Portfolio Optimization and Dynamic Asset Pricing

Author

Listed:
  • Davide Lauria

    (Department of Economics, Statistics and Finance, University of Calabria, 87036 Rende, CS, Italy)

  • W. Brent Lindquist

    (Department of Mathematics & Statistics, Texas Tech University, Lubbock, TX 79409-1042, USA)

  • Stefan Mittnik

    (Scalable Capital, 80538 Müchen, Germany)

  • Svetlozar T. Rachev

    (Department of Mathematics & Statistics, Texas Tech University, Lubbock, TX 79409-1042, USA)

Abstract

Environmental, social and governance (ESG) ratings (scores) provide quantitative measures for socially responsible investment. We consider ESG scores to be a third independent variable—on par with financial risk and return—and incorporate such numeric scores into dynamic asset pricing. Based on this incorporation, we develop the entire investment process for the ESG market: portfolio optimization and efficient frontier, capital market line (the market portfolio), risk-assessment measures and hedging instruments (options). There is currently no riskless asset available in such an ESG market; to address this, we develop the so-called shadow riskless rate, applicable to markets having only risky assets. We believe this to be the first paper that fully develops, under a single dynamic pricing framework, the entire investment process for an ESG market. As there are significant differences in methodologies developed by providers of ESG scores, we do not take the position that data from any single agency are to be favored. Consequently, we utilize ESG scores from Refinitiv in the manuscript’s empirical studies and redo all computations using S&P Global RobeoSAM ESG scores.

Suggested Citation

  • Davide Lauria & W. Brent Lindquist & Stefan Mittnik & Svetlozar T. Rachev, 2025. "Environmental, Social and Governance-Valued Portfolio Optimization and Dynamic Asset Pricing," JRFM, MDPI, vol. 18(3), pages 1-33, March.
    • Handle: RePEc:gam:jjrfmx:v:18:y:2025:i:3:p:153-:d:1611712
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    References listed on IDEAS

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    1. Thomas Berry & Joan Junkus, 2013. "Socially Responsible Investing: An Investor Perspective," Journal of Business Ethics, Springer, vol. 112(4), pages 707-720, February.
    2. Frittelli, Marco & Rosazza Gianin, Emanuela, 2002. "Putting order in risk measures," Journal of Banking & Finance, Elsevier, vol. 26(7), pages 1473-1486, July.
    3. Gunnar Friede & Timo Busch & Alexander Bassen, 2015. "ESG and financial performance: aggregated evidence from more than 2000 empirical studies," Journal of Sustainable Finance & Investment, Taylor & Francis Journals, vol. 5(4), pages 210-233, October.
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    Cited by:

    1. Ruike Wu & Yonghe Lu & Yanrong Yang, 2026. "Sustainable Investment: ESG Impacts on Large Portfolio," Papers 2602.14439, arXiv.org.
    2. Bhathiya Divelgama & Nancy Asare Nyarko & W. Brent Lindquist & Svetlozar T. Rachev & Blessing Omotade, 2025. "Path-dependent, ESG-valued, option pricing in the Bachelier-Black-Scholes-Merton model," Papers 2509.18099, arXiv.org.

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