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

Ian Berk, Massimo Guidolin and Monia Magnani

No 23202, BAFFI CAREFIN Working Papers from BAFFI CAREFIN, Centre for Applied Research on International Markets Banking Finance and Regulation, Universita' Bocconi, Milano, Italy

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

Keywords: ESG ratings; ESG momentum; ESG score volatility; cross-sectional pricing; systematic risk factor. (search for similar items in EconPapers)
JEL-codes: C59 G11 G12 G24 (search for similar items in EconPapers)
Pages: 52
Date: 2023
New Economics Papers: this item is included in nep-fmk and nep-rmg
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