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

Tinghua Duan, Frank Weikai Li, and Quan Wen

♦ 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.

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