MONIA MAGNANI

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.

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

We assess the performance of two quantitative signals based on ESG scores across a large, multi-national cross-section of European stock returns. We test whether the cost of equity capital is more influenced by the upward momentum (measured over time) of the ESG scores of the firms issuing stocks or by their stability (identified as the volatility of the scores over time), measured around a changing mean level. We find that short-term ESG momentum over 1 month has a significant impact on the cross-section of stock returns, lowering the anticipated cost of capital and leading to positive average abnormal returns. This suggests that short-term ESG momentum may represent a novel, priced systematic risk factor. Furthermore, we find strong evidence that an ESG volatility spread strategy which buys low ESG score volatility stocks and sells high volatility ones, generates a substantial alpha and affects the ex-ante cost of capital. Both quantitative ESG signals result in portfolio sorting and long-short strategies that enhance the overall sustainability profile of the issuing firms without compromising the raw average of their ESG scores.

New ESG rating drivers in the cross‐section of European stock returns - Berk - 2023 - Journal of Financial Research - Wiley Online Library