Climate Regulatory Risks and Corporate Bonds

68 Pages Posted: 17 Apr 2020 Last revised: 27 Dec 2023

See all articles by Lee Seltzer

Lee Seltzer

Federal Reserve Bank of New York

Laura T. Starks

University of Texas at Austin - Department of Finance

Qifei Zhu

Nanyang Business School, Nanyang Technological University

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Date Written: April 20, 2022

Abstract

Investor and policymaker concerns about climate risks suggest these risks should affect the risk assessment and pricing of corporate securities, particularly for firms facing stricter regulatory enforcement. Using corporate bonds, we find support for this hypothesis. Employing a shock to expected climate regulations, we show climate regulatory risks causally affect bond credit ratings and spreads. A structural credit model indicates the increased spreads for high carbon issuers, especially those located in stricter regulatory environments, are driven by changes in firms’ asset volatilities rather than asset values, highlighting that regulatory uncertainty affects security pricing. The results have important implications for policy-making.

Keywords: Climate Risk, Regulatory Risk, Fixed Income

JEL Classification: G38, G24, G00

Suggested Citation

Seltzer, Lee and Starks, Laura T. and Zhu, Qifei, Climate Regulatory Risks and Corporate Bonds (April 20, 2022). Nanyang Business School Research Paper No. 20-05, FRB of New York Staff Report No. 1014, Available at SSRN: https://ssrn.com/abstract=3563271 or http://dx.doi.org/10.2139/ssrn.3563271

Lee Seltzer

Federal Reserve Bank of New York ( email )

New York, NY
United States

HOME PAGE: http://https://sites.google.com/view/leeseltzer

Laura T. Starks (Contact Author)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-5899 (Phone)
512-471-5073 (Fax)

Qifei Zhu

Nanyang Business School, Nanyang Technological University ( email )

Singapore, 639798
Singapore

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