On Bond Returns in a Time of Climate Change
23 Pages Posted: 27 Mar 2020
Date Written: February 27, 2020
The study of the financial repercussions of low-carbon policy has focused mainly on stocks, leaving bonds out of the picture. The objective of this paper is to assess the impact of low-carbon policy upon European bond returns. This is done by extending the Fama and French (1993) two factor model for bonds with an EU-ETS compliance factor. The paper provides a highly statistically significant proxy for the risk factor in bond returns related to EU-ETS compliance, the GMC factor, and shows the presence of a statistically significant green premium in the European bond market. Furthermore, evidence is found that the addition of an environmental factor improves the performance of the original model in Europe. Lastly, the carbon stress test put forward is able to indicate the effects of a plausible but more severe average EU-ETS carbon price on bond returns.
Keywords: bond returns, low-carbon transition risks, green premium, EU-ETS, asset pricing model
JEL Classification: C38, G12, G32, Q58
Suggested Citation: Suggested Citation