Measuring ESG risk premia with contingent claims
Year: 2024
Type: article
Abstract: We propose a contingent claims approach for estimating ESG risk premia from market information and market participants’ decisions. To this end, we infer the asset value dynamics via the structural model of Merton (1974, Journal of Finance 29, 449-470) for a large panel of S&P 500 firms. Our estimation algorithm utilizes the information embedded in stock market prices, CDS spreads, and default probabilities, allowing us to accurately pin-down the core parameters of the model. We find a statistically significant relationship between the ESG score and the volatility and drift terms of the asset process, suggesting that ESG factors have a structural effect on the firm value. We establish a mapping between ESG scores and the cost of equity and debt as implied by firm’s contingent claims, and derive estimates of the ESG risk premium across different ESG and leverage profiles. In addition, we break down the ESG risk premia by industry, and demonstrate how practitioners can adjust the weighed average cost of capital of ESG laggard firms for valuation and decision making purposes.
Source: European Journal of Finance
Authors: Ioannis Michopoulos, Alexandros Bougias, Athanasios Episcopos, Efstratios Livanis
Language: English
Subfield: Strategy and Management
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W4402183722