Assessing the role of ESG evaluation in market risk management for sovereign bond investments

With the growing emphasis on responsible investing, the role of environmental, social, and governance (ESG) factors in risk management has become significant, extending to the field of sovereign bonds. This study examines the role of ESG evaluations in the risk management of sovereign bond investments. Across fifty countries, including developed and emerging countries, our findings indicate that, even after controlling each country's yield levels and fiscal conditions, nations with lower ESG scores tend to face higher market risks, notably regarding tail risk measures. This pattern is especially pronounced in the bonds of emerging countries. The research highlights that ESG evaluation of sovereign bonds can provide insight into the likelihood of unforeseen events, such as political turmoil and natural disasters, often not reflected in sovereign bond yields.