Are ESG ratings informative to forecast idiosyncratic risk?

Christophe Boucher (), Wassim Le Lann (), Stéphane Matton () and Sessi Tokpavi ()
Additional contact information
Wassim Le Lann: UO - Université d'Orléans, LEO - Laboratoire d'Économie d'Orleans [2022-...] - UO - Université d'Orléans - UT - Université de Tours - UCA - Université Clermont Auvergne

Working Papers from HAL

Abstract: This paper develops a backtesting procedure that evaluates how well ESG ratings help in predicting a company's idiosyncratic risk. Technically, the inference is based on extending the conditional predictive ability test of Giacomini and White (2006) to a panel data setting. We apply our methodology to the forecasting of stock returns idiosyncratic volatility and compare two ESG rating systems from Sustainalytics and Asset4 across three investment universes (Europe, North America, and the Asia-Pacific region). The results show that the null hypothesis of no informational content in ESG ratings is strongly rejected for firms located in Europe, whereas results appear mixed in the other regions. In most configurations, we find a negative relationship between ESG ratings and idiosyncratic risk, with higher ratings predicting lower levels of idiosyncratic volatility. Furthermore, the predictive accuracy gains are generally higher when assessing the environmental dimension of the ratings. Importantly, applying the test only to firms over which there is a high degree of consensus between the ESG rating agencies leads to higher predictive accuracy gains for all three universes. Beyond providing insights into the accuracy of each of the ESG rating systems, this last result suggests that information gathered from several ESG rating providers should be cross-checked before ESG is integrated into investment processes.

Keywords: Backtesting; ESG ratings; Idiosyncratic realised volatility; Test of equal predictive power; Panel data; Consensus ESG ratings (search for similar items in EconPapers)
Date: 2024-06-28
New Economics Papers: this item is included in nep-env, nep-fmk, nep-rmg and nep-sea
Note: View the original document on HAL open archive server: https://hal.science/hal-04140193v3
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://hal.science/hal-04140193v3/document (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:hal:wpaper:hal-04140193

Access Statistics for this paper

More papers in Working Papers from HAL
Bibliographic data for series maintained by CCSD ().