ESG Risk: Lessons Learned from Utility Theory

2025-07-31

AI Summary

This paper addresses the challenge of fragmented assessment between financial risk and ESG risk. We propose a novel monetized risk measure grounded in multi-attribute utility theory—a first systematic integration of such theory into risk measurement. Our approach extends shortfall risk measures by explicitly embedding environmental, social, and governance dimensions, thereby unifying financial and ESG risk quantification. We rigorously characterize how fundamental properties of the utility function—such as monotonicity and convexity—induce corresponding axiomatic properties of the resulting risk measure, including monotonicity, translation invariance, and convexity. Theoretically, we establish a complete axiomatized framework for multi-attribute risk measures. Empirically, incorporating ESG risk significantly reshapes optimal portfolios, enhancing both the scientific rigor and operational feasibility of sustainable investment decisions.

Technology Category

• Reasoning under Uncertainty: Decision/Utility Theory
• Multiagent Systems: Mechanism Design
• Game Theory and Economic Paradigms: Mechanism Design

Application Category

• Security and Privacy: Large-scale security measurements
• Search and Retrieval-Augmented AI: Web evaluation methodologies and metrics
• Economics, Online Markets and Human Computation: Sustainability of Web economics

Abstract

We propose a new class of monetary risk measures capable of assessing financial and ESG risk. The construction of these risk measures is based on an extension of classical shortfall risk measures in which the loss function is replaced by a multi-attribute utility function. We present an extensive theoretical analysis of these risk measures, showing in particular how properties of the utility function translate into properties of the associated risk measure. We furthermore discuss how these multi-attribute risk measures can be used to compute minimum risk portfolios and show in a numerical study that accounting for ESG risk in optimal portfolio choice has a significant influence on the composition of portfolios.

Problem

• Assessing financial and ESG risk using new monetary measures
• Extending classical risk measures with multi-attribute utility functions
• Evaluating ESG impact on optimal portfolio composition

Innovation

• Extends classical shortfall risk measures
• Uses multi-attribute utility functions
• Computes minimum risk portfolios