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I have observed that my portfolios constructed according to positive ESG criteria consistently show negative alphas and positive momentum, while the portfolios with negative ESG criteria show positive alphas and negative momentum.

I'm not sure how to interpret this correctly in economic terms:

Would be this interpretation correct?:

One reason could be that the portfolio with negative ESG criteria had below average returns in the past and was therefore under pressure, which led to an undervaluation of the stocks, which later reversed and led to the positive alpha.

Portfolio construction: I used the FF5 plus momentum. I first sorted my stocks by their annual ESG scores. Then I created a portfolio based on the ESG quantiles of the companies and let it run for 7 years. Each year I rebalanced the portfolios based on the ESG scores and quantiles. I then regressed the monthly returns on the FF factors. I noticed that the portfolios with higher ESG scores in particular have a negative alpha and positive momentum, while the portfolios with more negative ESG scores have a positive alpha and negative momentum (both always significant).

Thanks in advance

Greetings

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  • $\begingroup$ Why don't you perform a contemporaneous regression of stock returns to your ESG criteria over a time interval? Significant coefficients would mean that your ESG criteria do indeed explain the returns. $\endgroup$
    – KaiSqDist
    Commented Jun 1 at 11:07
  • $\begingroup$ Is this possible, i just have yearly ESG criteria on which i construct my portfolio and my stocks are monthly. What would be my independent variables? $\endgroup$
    – Michael123
    Commented Jun 1 at 11:21
  • $\begingroup$ Hi Michael, I added my comment as an answer instead. Hopefully it helps! $\endgroup$
    – KaiSqDist
    Commented Jun 1 at 13:48
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    $\begingroup$ Thank you very much for your answers, i edited the question $\endgroup$
    – Michael123
    Commented Jun 3 at 10:35
  • $\begingroup$ The negative (positive) alphas are dictated by the value of the intercepts? $\endgroup$
    – KaiSqDist
    Commented Jun 3 at 10:55

1 Answer 1

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Usually the frequencies should be the same. If it were up to me, I would keep the ESG criteria constant per the year during the regression.

Your independent variables are up to you, but there is a lot of research on factors that could explain the returns. For example, you could use the Fama-French factors, style, momentum, even economic variables could be useful to control for factors that result in the returns.

I would say this is the most important part of the return explanation.

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