I'm writing my thesis on the relationship between financial performance and sustainability. For that I'm comparing the returns of 2 portfolios, the first having really good ESG scoring firms, while the second portfolio consists of similar firms to the first (same peer group), but showing poorer ESG scores. I'm then using the Fama and French 3 Factor model, while integrating a new ESG factor in the regression. However I'm having some trouble building that variable. Can someone help ?
If you just want to compare the portfolios you could work with a dummy variable (A column in your data which is "1" for the ESG firms and "0" for the non-ESG firms). The regression output will then state the impact of such a variable.
Alternatively, if you intend to measure the impact of an ESG-Score/Rating on the individual portfolio constituents, you could add such a Score as an explanatory variable.