Carbon Emissions, Mutual Fund Trading, and the Liquidity of Corporate Bonds

Abstract

This paper investigates how firms' carbon emission levels affect the trading behavior of bond mutual funds. We find that mutual funds collectively sell corporate bonds issued by firms with high carbon emissions, driven by funds' concerns for carbon-related redemption risks and regulatory risks, rather than by a permanent shift in funds' investing preferences. Higher carbon exposures in mutual fund portfolios lead to more investor outflows, and bonds tend to experience more intensive selling if their holding mutual funds have higher flow-to-carbon sensitivity. Bonds issued by high carbon firms experience worse liquidity conditions, especially when concerns for carbon-related risks heighten.

Keywords: Carbon emissions, corporate bonds, mutual funds, collective selling, redemption risks, liquidity

JEL Classification: G11, G20, G23, G41