ESG Risk and Market Return Predictability: New Evidence From the Eurozone

This study examines the predictive power of incident-based Environmental, Social and Governance (ESG) risk on the Eurozone stock market returns using a forecast combination method. We find that our constructed indicator shows significant return predictability from both a statistical and economic perspective, with an out-of-sample CER gain of 4.55% and a Sharpe ratio of 0.43, consistently outperforming the mean benchmark. Moreover, we find that the predictive power is concentrated during non-expansion periods. We attribute this mechanism to the firm's fundamentals, cash flow and discount rate channels. Our findings highlight the value of ESG information for investors