Inclusion of ESG Ratings in Optimization

W. Brent Lindquist, Svetlozar T. Rachev, Yuan Hu and Abootaleb Shirvani
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W. Brent Lindquist: Texas Tech University
Svetlozar T. Rachev: Texas Tech University
Yuan Hu: University of California San Diego
Abootaleb Shirvani: Kean University

Chapter Chapter 13 in Advanced REIT Portfolio Optimization, 2022, pp 227-245 from Springer

Abstract: Abstract ESG scores have become the tool to quantify the social responsiveness of asset issuing entities. This chapter develops the framework of ESG-valuation, under which the value of a traded asset is based upon both its financial and ESG components. The relative weighting of the two is controlled by an ESG affinity parameter. Beginning with the concept of an ESG-valued return, application of modern portfolio theory leads to optimization in a three-dimensional space defined by expected ESG-value, an associated risk measure, and ESG score. Efficient frontiers, capital market lines, risk-minimizing and tangent portfolios are definable in this space, leading to optimized, ESG-valued portfolios. This approach is applied to the domestic REIT portfolio using ESG-valued conditional value-at-risk and dynamic optimization. The behavior of its ESG-valued efficient frontiers and the tangent portfolios derived from them are studied as the value of the affinity parameter changes.

Date: 2022
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DOI: 10.1007/978-3-031-15286-3_13

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