Inclusion of ESG Ratings in Optimization

W. Brent Lindquist, Svetlozar T. Rachev, Yuan Hu, Abootaleb Shirvani

Research output: Chapter in Book/Report/Conference proceedingChapterpeer-review

4 Scopus citations

Abstract

ESG scores have become the tool to quantify the social responsiveness of asset issuing entities. This chapter develops the framework of ESG-valuation, under which the value of a traded asset is based upon both its financial and ESG components. The relative weighting of the two is controlled by an ESG affinity parameter. Beginning with the concept of an ESG-valued return, application of modern portfolio theory leads to optimization in a three-dimensional space defined by expected ESG-value, an associated risk measure, and ESG score. Efficient frontiers, capital market lines, risk-minimizing and tangent portfolios are definable in this space, leading to optimized, ESG-valued portfolios. This approach is applied to the domestic REIT portfolio using ESG-valued conditional value-at-risk and dynamic optimization. The behavior of its ESG-valued efficient frontiers and the tangent portfolios derived from them are studied as the value of the affinity parameter changes.

Original languageEnglish
Title of host publicationDynamic Modeling and Econometrics in Economics and Finance
PublisherSpringer Science and Business Media Deutschland GmbH
Pages227-245
Number of pages19
DOIs
StatePublished - 2022

Publication series

NameDynamic Modeling and Econometrics in Economics and Finance
Volume30
ISSN (Print)1566-0419
ISSN (Electronic)2363-8370

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