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

Abstract

This paper provides a detailed investigation on how firms’ carbon emission levels affect trading behaviors of mutual funds and liquidity conditions of corporate bonds. Our analysis is conducted with a full sample from 2007 to 2019 and causality is further established by exploiting the Paris Agreement. We find that mutual funds are more likely to sell corporate bonds in herds if the bonds’ issuing firms have higher carbon emissions, driven by funds’ concerns for carbon-related redemption risks and regulatory risks, rather than by a permanent change in investing ethics or preferences. We show that higher carbon exposures in mutual fund portfolios lead to more investor outflows, and bonds tend to experience more sell herding if their holding mutual funds have higher flow-to-carbon sensitivity. We also find that bonds issued by high-carbon firms experience worse liquidity conditions.

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

JEL Classification: G11, G20, G23, G41