Correlations of ESG Ratings: A Signed Weighted Network Analysis

Abstract

ESG ratings are data-driven indices, focused on three key pillars (Environmental, Social, and Governance), which are used by investors in order to evaluate companies and countries, in terms of Sustainability. A reasonable question which arises is how these ratings are associated to each other. The research purpose of this work is to provide the first analysis of correlation networks, constructed from ESG ratings of selected economies. The networks are constructed based on Pearson correlation and analyzed in terms of some well-known tools from Network Science, namely: degree centrality of the nodes, degree centralization of the network, network density and network balance. We found that the Prevalence of Overweight and Life Expectancy are the most central ESG ratings, while unexpectedly, two of the most commonly used economic indicators, namely the GDP growth and Unemployment, are at the bottom of the list. China’s ESG network has remarkably high positive and high negative centralization, which has strong implications on network’s vulnerability and targeted controllability. Interestingly, if the sign of correlations is omitted, the above result cannot be captured. This is a clear example of why signed network analysis is needed. The most striking result of our analysis is that the ESG networks are extremely balanced, i.e. they are split into two anti-correlated groups of ESG ratings (nodes). It is impressive that USA’s network achieves 97.9% balance, i.e. almost perfect structural split into two anti-correlated groups of nodes. This split of network structure may have strong implications on hedging risk, if we see ESG ratings as underlying assets for portfolio selection. Investing into anti-correlated assets, called as "hedge assets", can be useful to offset potential losses. Our future direction is to apply and extend the proposed signed network analysis to ESG ratings of corporate organizations, aiming to design optimal portfolios with desired balance between risk and return.

Keywords

• ESG ratings
• network analysis
• signed network
• weighted network
• centrality
• centralization