Responsible Minus Irresponsible - a determinant of equity risk premia?

Thomas Husse and Federico Pippo

Journal of Sustainable Finance & Investment, 2024, vol. 14, issue 3, 619-641

Abstract: This study attempts to explain the relationship between ESG and financial performance. It utilises a new method for constructing an ESG portfolio with a high exposure towards ESG that eliminates the inherent correlation between size and ESG. In that perspective, a zero initial investment portfolio that goes long in responsible companies and short in irresponsible companies is adopted; hence, developing a ‘Responsible Minus Irresponsible’ (RMI) factor mimicking portfolio. A pricing anomaly test on this portfolio suggests that ESG exerts superior financial performance, mostly as a result of a significant lower market risk. Performing a cross-sectional analysis of different factor models on an international set of company returns indicates a negative effect of ESG on expected returns. However, the ESG factor becomes insignificant once multiple factors are introduced as explanatory variables. Consequently, ESG represents a pricing anomaly but does not act as an independent risk factor.

Date: 2024
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DOI: 10.1080/20430795.2021.1961557

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