Climate Regulatory Risks and Corporate Bonds

Abstract

Concerns about climate risk suggest it should affect risk assessment and pricing of corporate securities, particularly for firms facing potential regulatory restrictions. Employing a shock to expected climate regulations, we find support for this hypothesis given our evidence that climate regulatory risks causally affect bond credit ratings and yield spreads. Moreover, a structural credit model indicates the increased spreads for high carbon issuers, especially those located in stricter regulatory environments, derive from changes in firms' asset volatilities rather than asset values, highlighting that regulatory uncertainty affects security pricing. The results have important implications for corporate decisions, portfolio management, and policymaking.

Keywords: Climate Risk, Regulatory Risk, Fixed Income, carbon emissions, environmental policy, corporate bonds

JEL Classification: G38, G24, G00