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

Journal of Financial and Quantitative Analysis (JFQA), Forthcoming

84 Pages Posted: 24 Nov 2020 Last revised: 17 Oct 2023

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

McDonough School of Business, Georgetown University

Date Written: January 3, 2021

Abstract

This paper examines the pricing of a firm's carbon risk in the corporate bond market. Contrary to the "carbon risk premium" hypothesis, bonds of more carbon-intensive firms 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 alpha, 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 the predictability of carbon intensity for firm cash-flow news, creditworthiness, and environmental incidents.

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). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming, 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)

McDonough School of Business, Georgetown University ( email )

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

HOME PAGE: http://quan-wen.facultysite.georgetown.edu/home

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