ESG and the Stock Market: is ESG Exposure Systematic?

We study the relation between firms' environmental, social, and governance (ESG) performance and the aggregate stock market returns. Based on 38 individual ESG measures, we construct a market-level ESG index. With both the traditional predictive regression approach and two recently developed machine-learning methods, we find that the ESG index has strong and positive predictive power on the market both in-and out-of-sample, and both the cash flow and discount rate channels are the economic drivers of predictability. Our results are robust to a number of controls and set-ups. Our novel finding on the significant market-wide impact of the ESG provides support for the economy-wide importance of the ESG risk and for the central role played by governments.