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Strong vs. Stable: The Impact of ESG Ratings Momentum and their Volatility on the Cost of Equity Capital

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  • Ian Berk
  • Massimo Guidolin
  • Monia Magnani

Abstract

We test the performance of two ESG score-driven quantitative signals on a large, multi-national crosssection of European stock returns. In particular, we ask whether in the cross-section, the cost of equity capital is more strongly affected by the (upward) “slope” (identified as momentum over a period of time) of their ESG scores or by their “stability” (identified as the volatility of the scores over a period of time), measured around a given slope. We find that 1 month, short-term ESG momentum is priced in the cross-section of stock returns and that it lowers the ex-ante cost of capital (at the same time causing realised ex post average abnormal returns). Short-term ESG momentum may represent a novel, priced systematic risk factor. There is equally strong evidence that a ESG spread strategy that buys (sells) low (high) ESG score volatility stocks leads to a significant alpha and alters the ex-ante cost of capital. Both quantitative ESG signals lead to portfolio sorts and long-short strategies that increase the speed of improvement of the aggregate sustainability profile of the resulting portfolios with no costs in terms of average ESG scores or their stability

Suggested Citation

  • Ian Berk & Massimo Guidolin & Monia Magnani, 2023. "Strong vs. Stable: The Impact of ESG Ratings Momentum and their Volatility on the Cost of Equity Capital," BAFFI CAREFIN Working Papers 23202, BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy.
    • Handle: RePEc:baf:cbafwp:cbafwp23202
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    More about this item

    Keywords

    ESG ratings; ESG momentum; ESG score volatility; cross-sectional pricing; systematic risk factor.;
    All these keywords.

    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
    • C59 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Other
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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