High idiosyncratic risk and low expected returns

: the role of ESG engagement

Abstract

Scholars have established a positive relation between risk and return, particularly with the introduction of the CAPM. However, evidence on whether this relationship extends to idiosyncratic risk and returns remains inconclusive. While Ang et al. (2006, 2009) identified a negative relation between lagged idiosyncratic volatility and expected returns, Fu (2009) reported a positive relation between expected idiosyncratic volatility and expected returns. This thesis revisits this debate, while controlling for ESG engagement. The findings reveal (1) a negative relation between lagged, realized, and expected idiosyncratic risk with expected stock returns, (2) controlling for ESG Scores does not significantly impact this relationship, and (3) high ESG stocks were, on average, less exposed to idiosyncratic risk and its variability compared to low ESG stocks. These results challenge conventional risk-based explanations of expected stock returns and highlight the importance of ESG engagement in effectively mitigating risk.

Date of Award	27 Jan 2025
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Zoe Venter (Supervisor)