Is Carbon Risk Priced in the Cross Section of Corporate Bond Returns?
72 Pages Posted: 24 Nov 2020 Last revised: 4 Jan 2021
Date Written: January 3, 2021
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: Suggested Citation