Assessing the Impact of Environmental, Social and Governance (ESG) Factors on Asset Pricing: A GMM Analysis

Abstract

This paper investigates the impact of Environmental, Social, and Governance (ESG) factors on asset pricing using a Generalized Method of Moments (GMM) estimation framework. The study aims to determine whether ESG scores are priced in financial markets, influencing risk-adjusted returns of assets. This study analyzes a panel of 100 publicly listed firms of China over a five-year period from 2019 to 2023. The firms are selected based on their availability of ESG scores from leading data providers (MSCI, Bloomberg) and financial data from widely used sources such as Compustat and CRSP. We find a significant negative relationship between ESG scores and excess returns. Specifically, firms with higher ESG ratings tend to exhibit lower excess returns, indicating that investors may accept lower returns in exchange for sustainability and reduced risk exposure. While traditional factors such as the market, size (SMB), and value (HML) continue to play significant roles in asset pricing, ESG factors are shown to influence returns in a manner consistent with risk-reduction theories. This study contributes to the growing literature on ESG investing, providing empirical evidence of ESG's role in asset pricing. The findings suggest that while ESG investing does not necessarily generate superior returns, it offers a risk-reducing strategy that aligns with investor preferences for ethical and sustainable business practices. The paper concludes with implications for investors, policymakers, and future research on the integration of ESG in financial markets.