Working Paper: CEPR ID: DP16392
Authors: Ilias Filippou; Mark Taylor
Abstract: We examine the cross-sectional predictive ability of the Refinitiv Environmental, Social and Governance (ESG) score for returns in the foreign exchange market, using ESG scores aggregated at the national level, and find that ESG is a strong negative predictor of currency returns. Intuitively, investors require a premium for financing low-ESG countries while high-ESG countries offer lower returns and provide a hedge in the bad state of the world. We show that ESG is priced in the cross-section of currency returns. We also consider the different components of ESG and show that its predictability is driven by the environmental pillar of the ESG ratings. The profitability of the ESG currency strategy is not driven by the carry trade and is robust to transaction costs.
Keywords: Environmental; Social; Governance; Refinitiv; ESG; Foreign Exchange Market; Risk Premium
JEL Codes: F31; G11; G12; G14; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ESG ratings (G24) | Currency returns (F31) |
| Environmental component of ESG (Q56) | Currency returns (F31) |
| High ESG scores (Q56) | Lower currency returns (F31) |
| Low ESG scores (G33) | Higher currency returns (F31) |
| Environmental component of ESG (Q56) | Currency risk (F31) |
| ESG-based currency strategy (G15) | Transaction costs (D23) |