ESG and the market return

• Main Authors: CHANG, Ran, CHU, Liya, Jun TU, ZHANG, Bohui, ZHOU, Guofu
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2021
• Subjects: ESG; Return Predictability; Partial Least Square; Elastic Net; Out-of-sample Forecast; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/6899; https://ink.library.smu.edu.sg/context/lkcsb_research/article/7898/viewcontent/SSRN_id3869272.pdf
• Institution: Singapore Management University

We propose an environmental, social, and governance (ESG) index. We find that it has significant power in predicting the stock market risk premium, both in- and out-of-sample, and delivers sizable economic gains for mean-variance investors in asset allocation. Although the index is extracted by using the PLS method, its predictability is robust to using alternative machine learning tools. We find further that the aggregate of environmental variables captures short-term forecasting power, while that of social or governance captures long-term. The predictive power of the ESG index stems from both cash flow and discount rate channels.