Can ESG performance shape dynamic risk spillovers? Evidence from Chinese carbon and equity markets

• Industries with lower ESG scores contribute to a greater degree of return spillover to the carbon market • Investor attention mediates the relationship between ESG ratings and carbon market spillover. • Portfolios comprising industries with lower ESG scores and the carbon market show higher risk and lower returns This paper investigates the impact of ESG score on the risk spillover effect between China's carbon market and stock markets, especially the exact transmission mechanisms for such effects to function. Employing the least absolute shrinkage and selection operator-vector autoregressive-Diebold-Yilmaz spillover (LASSO-VAR-DY) method, we assess the degree and direction of return spillovers between these markets. The empirical findings reveal that industries with lower ESG scores have a slightly higher net spillover effect on the carbon market compared to those with higher ESG scores, with the carbon market being the net receiver of return spillovers. Additionally, we identify investor attention as a complete mediator in the relationship between ESG ratings and the net spillover from industries to the carbon market. Portfolios constructed with the carbon market and industries exhibiting lower spillover effects demonstrate lower risk and higher returns.