How to Estimate the Impact of an Issuer’s ESG Risk on the Yield of its Bonds

Abstract

All over the world, the ESG agenda is receiving more and more attention from the leadership of countries, international organizations and companies. These trends can be reflected both in the operating activities of companies and in the way they raise funds in financial markets, as well as in the pricing of financing instruments such as bonds. The subject of the study is the yield of circulating bonds of issuers with a credit rating, as well as ESG risk expressed by the ESG rating assigned to the issuer. The aim of the study is to develop the author’s theoretical and methodological approach to modeling the pricing of bonds and calculating their yield to maturity, which, in addition to generally accepted factors, also takes into account the issuer’s ESG risks. The methodological base of the study includes the analysis and comparison of the yield to maturity of bonds of corporate borrowers against the zero-coupon yield curve of federal loan bonds, ratings of rating agencies regarding the creditworthiness of issuers and their ESG risks. The author uses the total risk premium approach and evaluates the risk premium for investing in the issuer’s bonds as the sum of premiums for certain types of risks. At the same time, the author proposes an author’s modification of this approach in order to take into account the grade of the issuer’s ESG rating in the risk premium of its bonds and, accordingly, their yield to maturity, which is the scientific novelty and relevance of this work. Based on the performed mathematical modeling, the obtained results demonstrate that investors differently evaluate the required yield to maturity for an asset, depending on the grade of the issuing company’s ESG rating. In addition to describing the observed non-linear relationship between the factors that characterize the company, its bond issues and the return required by investors, modeling makes it possible to conclude that in the current realities, the investment idea to invest in Russian companies that follow the concept of sustainable development is conservative. Following sustainable development strategies by a larger number of companies from different industries and regions, together with the development of regulation, will lead to the further development of the green finance market in Russia and the world, and an increase in the coverage of companies by rating agencies. This will provide the author’s approach with development prospects, in particular, the modeling will be enriched with a large amount of input data, it will take into account a larger number of companies and their bond issues, and the possibility of adding new factors to the model will be studied.