Measuring ESG risks in multi-asset portfolios: Decomposing VaRESG into CVaRESG

• Published in: Finance research letters Vol. 66; p. 105692
• Main Authors: Capelli, Paolo, Ielasi, Federica, Russo, Angeloantonio
• Format: Journal Article
• Language: English
• Published: Elsevier Inc 01.08.2024
• Subjects: Component value-at-risk; ESG risk; Financial portfolio decomposition; Market risk; VaR; Volatility; ESG risk; Component value-at-risk; Volatility; VaR; Market risk; G21; Financial portfolio decomposition; G01; L10; G28
• ISSN: 1544-6123; 1544-6131
• DOI: 10.1016/j.frl.2024.105692

•The study presents a new methodology to decompose VaRESG, a measure of VaR that integrates ESG risks, to obtain the correspondent Component VaRESG.•This bottom-up methodology identifies the risk contribution of each security, by considering both its traditional financial risk and its exposure to ESG risk.•Component VaRESG reduces unexpected losses, especially under stressful conditions.•Component VaRESG can be used for defining specific risk limits in terms of individual security, geographical area, economic sector, and asset type.•Results are relevant for portfolio managers who intend to implement risk management practices compliant with sustainable finance legislation. This study investigates the contribution of different asset classes to investment portfolio risk by integrating environmental, social, and governance (ESG) factors into traditional financial risk measures. We propose a new methodology for decomposing VaRESG by measuring the Component VaRESG (CVaRESG) of a multi-asset financial portfolio. A pilot empirical application's results provide evidence of the reliability of CVaRESG to define the maximum contribution of the risk accepted for securities or parts of the financial portfolio. This study contributes to the debate on how ESG factors can have quantifiable long-term financial impacts and clarifies the risk contribution of each security included in a financial portfolio.