Is Carbon Risk Priced in the Cross Section of Corporate Bond Returns?

72 Pages Posted: 24 Nov 2020 Last revised: 4 Jan 2021

See all articles by Tinghua Duan

Tinghua Duan

IESEG School of Management

Frank Weikai Li

Singapore Management University - Lee Kong Chian School of Business

Quan Wen

Georgetown University - Department of Finance

Date Written: January 3, 2021

Abstract

This paper examines the pricing of a firm's carbon risk, measured by its carbon emissions intensity, in the cross section of corporate bond returns. Contrary to the "carbon risk premium'' hypothesis, we find bonds of firms with higher carbon emissions intensity earn significantly lower returns. This effect cannot be explained by a comprehensive list of bond characteristics and exposure to known risk factors. Investigating sources of the low carbon premium, we find the underperformance of bonds issued by carbon-intensive firms cannot be fully explained by divestment from institutional investors. Instead, our evidence is most consistent with investor underreaction to carbon risk, as carbon emissions intensity is predictive of lower future cash flow news, deteriorating firm creditworthiness, more environmental incidents, and elevated downside risks.

Keywords: Climate change, Carbon emissions, Corporate bond returns, ESG investing

JEL Classification: G1, G12, G14

Suggested Citation

Duan, Tinghua and Li, Frank Weikai and Wen, Quan, Is Carbon Risk Priced in the Cross Section of Corporate Bond Returns? (January 3, 2021). Available at SSRN: https://ssrn.com/abstract=3709572 or http://dx.doi.org/10.2139/ssrn.3709572

Tinghua Duan

IESEG School of Management ( email )

Socle de la Grande Arche
1 Parvis de la Defense
Puteaux, Paris 92800
France

Frank Weikai Li

Singapore Management University - Lee Kong Chian School of Business ( email )

469 Bukit Timah Road
Singapore 912409
Singapore

Quan Wen (Contact Author)

Georgetown University - Department of Finance ( email )

37th and O Street, NW
Washington D.C., DC 20057
United States

HOME PAGE: http://faculty.georgetown.edu/qw50

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