Strong vs. stable: the impact of ESG ratings momentum and their volatility on the cost of equity capital

Monia Magnani (), Massimo Guidolin and Ian Berk ()
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Ian Berk: Bocconi University

Journal of Asset Management, 2024, vol. 25, issue 7, No 4, 666-699

Abstract: Abstract We test whether in the cross-section of European stocks, 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 short-term ESG momentum is priced in the cross-section of stock returns but that it may increase or decrease the ex-ante cost of capital depending on the specific sample investigated. While short-term ESG momentum may represent a novel, priced systematic risk factor, there is also strong evidence that a ESG spread strategy that buys (sells) low (high) ESG score volatility stocks leads to a significant alpha and lower the ex-ante cost of capital. This suggests that ESG rating stability may carry a more reliable reward than improvements do, in terms of ex-ante equity cost of capital. These results are robust to the use of different sub-samples (over firms and sub-periods) and to forming the two quantitative ESG signals on the basis of alternative rating data.

Keywords: ESG ratings; ESG momentum; ESG score volatility; Cross-sectional pricing; Systematic risk factor; G11; G12; C59; G24 (search for similar items in EconPapers)
Date: 2024
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Working Paper: Strong vs. Stable: The Impact of ESG Ratings Momentum and their Volatility on the Cost of Equity Capital (2023)
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DOI: 10.1057/s41260-024-00377-w

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