Summary

Abstract

This paper investigates the possible impact of ESG Risk when incorporated into front office driven Fundamental Market Risk Measurement approaches. The main principle is, that ESG risk is implicitly embedded in observable market risk factors, like share prices and credit spreads, and interprets the ESG risk of an equity portfolio as an additional jump component to an ordinary GBM process. The simulation results show that on a 250 trading day horizon Environmental Risk is on a diversified portfolio level only relevant for longer time horizons (e.g. greater than 50 days), or in case of stressed scenarios. Our simulations indicate, that environmental rating based Exclusion Lists and Exposure Limits on companies with low environmental rating, would already do the job of managing or - more precisely - efficiently restricting current ESG risk. Finally, we derive modification factors that enable the user to adjust a Historical VaR simulation appropriately to consider ESG Risk.

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Authors

LMU (University of Munich)