ESG sharpe ratio frontier

Abstract

Despite the recent proliferation in interest and in research regarding ESG strategies, a mixed review still holds as to whether the approach actually produces excess financial returns. To tackle this debate in depth, this paper examines the empirical analysis of ESG-Sharpe Ratio Frontier and ESG-adjusted CAPM in the Korean market. Important findings from the empirical result were that 1) ESG score does have statistically significant positive relationship with excess financial return, 2) the cost of the ESG strategy was consistently higher for decrease in ESG than increase, while the benefit showed mixed results, and 3) standard Markowitz portfolio scored higher Sharpe ratio than the ESG-strategy portfolios. Overall, these findings indicated that ESG strategy is a suboptimal portfolio. However, the domestic empirical findings have some disagreements with the study based on S&P500 from Pederson et al. (2021), who initially introduced the theoretical framework. We cannot cross out the potential effects of country-specific anomalies such as the “chaebol effect” in Korea, which may indicate that perhaps a multi-country analysis is needed for future research. Furthermore, we suggest other potential reasons for the differences in the empirical results such as the limitation of the theoretical framework, sample covariance matrix calculation error, and the small number of sample data.