ESG Risk: Lessons Learned from Utility Theory

TL;DR

This paper introduces a new class of monetary risk measures incorporating ESG factors through multi-attribute utility functions, providing a theoretical foundation and demonstrating their impact on portfolio optimization.

Contribution

It develops a novel framework for ESG risk assessment using utility-based risk measures and analyzes their properties and applications in portfolio management.

Findings

Multi-attribute risk measures reflect ESG considerations effectively.

Inclusion of ESG risk significantly alters optimal portfolio composition.

Theoretical analysis links utility properties to risk measure characteristics.

Abstract

We propose a new class of monetary risk measures for assessing financial and ESG risk. The construction is based on classical shortfall risk measures with loss function replaced by a multi-attribute utility function. We present an extensive theoretical analysis of these risk measures, showing specifically how properties of the utility function translate into properties of the associated risk measure. We furthermore discuss how these multi-attribute risk measures can be used to compute minimum risk portfolios and show in a numerical study that accounting for ESG risk in optimal portfolio choice has a significant influence on the composition of portfolios.