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Responsible investments reduce market risks

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Abstract

Responsible investments are considered one of the driving factors of revenues growth enhancing risk-adjusted returns. This paper investigates the effects of responsible investments on the volatility of European stock returns. First, we exploit an expectation–maximization (E–M) algorithm to cluster the companies into two groups according to the Environmental score (E), used as a proxy for responsible investments. Second, we build one global minimum variance (GMV) portfolio within each group and estimate its volatility using ARCH-type models. Finally, we forecast well-known risk measures such as the value-at-risk (VaR) and the expected tail loss (ETL) to assess market risks for investing green. Responsible portfolios composed of stocks with high E score outperform their Low E counterparts and are shown to be safer choices to mitigate risks, especially during periods of market distress. The results are remarkable for many sectors.

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Notes

  1. The algorithm converges when the gain in terms of maximization of distance between and minimization of distance within clusters goes to zero.

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Acknowledgements

We thank the Editors and two anonymous referees for helpful comments that improved the quality of the paper. We also acknowledge Antonello Iapicca and Gianfranco Marcelli for thought-provoking discussions about the role of responsible investments in the society.

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  1. Department of Statistical Sciences, Sapienza University of Rome, Rome, 00185, Italy

    Giacomo Morelli & Rita D’Ecclesia

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  1. Giacomo Morelli
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Correspondence to Giacomo Morelli.

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Morelli, G., D’Ecclesia, R. Responsible investments reduce market risks. Decisions Econ Finan 44, 1211–1233 (2021). https://doi.org/10.1007/s10203-021-00351-w

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