Greener pastures, steadier returns: ESG ratings and idiosyncratic risk management

Understanding China's Environmental, Social, and Governance (ESG) dynamics is crucial, given the nation's swiftly changing regulatory landscape, varied industry sectors, and significant global market impact. We validate the connection between ESG ratings and idiosyncratic volatility that the three-factor model gauges. Our model underscores that ESG ratings are instrumental in mitigating idiosyncratic volatility at the firm level. However, the associated effects vary by firm attributes, industry sectors, pollution levels, and regions. The moderation analysis reveals that investor sentiment, economic policy uncertainty, and financial constraints are critical thresholds affecting the connection between ESG ratings and corporate idiosyncratic volatility. Specifically, when economic policy uncertainty and financial constraints surpass certain thresholds, the mitigating effect of ESG ratings on idiosyncratic volatility diminishes. These findings are invaluable for stakeholders dealing with the complexities of ESG investments and sustainable business practices in a rapidly evolving global context.