Option traders are concerned about climate risks: ESG ratings and short-term sentiment

Abstract

This paper examines the potential relationship between ESG factors and short-term investor sentiment derived from option markets. We test whether ESG factors are related to short-term investor sentiment for US companies, using portfolio sorts and dynamic panel regressions. The results reveal firstly, that the difference between the highest and lowest ESG, ‘E’, ‘S’, and ‘G’ rated portfolios is negative and significant, showing that those firms in the highest ESG rated portfolio are receiving significantly more optimistic sentiment than those in the lowest portfolio. Secondly, we show that only the ‘E’ score and ESG controversies score are significant factors in option traders’ sentiment in our multivariate setting, with better scores in these factors significantly improving sentiment. These results persist within a sector analysis, in the materials, consumer discretionary, communications, utilities, and real estate sectors. This paper shows that the most sophisticated investors (options traders) are considering environmental risks of individual companies.