The enhanced gain effects of ESG's non-linearity on portfolios: An asset pricing tree model perspective

• Published in: International review of financial analysis 2025-03, Vol.99, p.103971, Article 103971
• Main Authors: Du, Puliang, Gu, Runsheng, Luo, Ling, Xie, Fei, Zhang, Chenyang
• Format: Article
• Language: English
• Subjects: Asset pricing model; ESG; Fama-French three-factor model; Non-linearity; Pricing error
• ISSN: 1057-5219
• DOI: 10.1016/j.irfa.2025.103971

This study investigates the incremental benefits of ESG criteria on investment portfolio performance, with a particular focus on the non-linear attributes of ESG factors. Employing linear regression models, the research establishes that ESG factors contribute supplementary information to investment portfolios, thereby augmenting the models' explanatory power regarding returns. The integration of ESG data with financial data within an asset pricing framework is further explored, revealing that non-linear integration surpasses conventional linear integration techniques. The findings indicate that the positive impact of ESG information on investment portfolios intensifies with the maturation of regulatory frameworks, manifesting a distinctive efficacy in non-linear models that transcends the capabilities of traditional financial metrics. While ESG metrics offer significant insights for portfolio construction, their correlation with corporate performance is not strictly linear. Moreover, the study demonstrates that the efficacy of ESG varies across different corporate entities, influenced by sector-specific and market capitalization factors. This variability suggests that the strategic application of ESG in investment strategies, when combined with other financial indicators, is more likely to maximize the value of ESG data. •Confirms ESG's ability to provide unique insights beyond traditional financial data.•Utilizes asset pricing tree model to explore ESG's non-linear effects on portfolios.•Introduces asset pricing tree model to enhance ESG integration in investment.•Examines varying ESG responses across industries with different pollution levels.