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

Published online by Cambridge University Press:  20 June 2023

Tinghua Duan ,
Frank Weikai Li  and
Quan Wen Open the ORCID record for Quan Wen [Opens in a new window]
Tinghua Duan
Affiliation:
IESEG School of Management, Université de Lille, CNRS, UMR 9221 – LEM – Lille Economie Management t.duan@ieseg.fr
Frank Weikai Li
Affiliation:
Singapore Management University Lee Kong Chian School of Business wkli@smu.edu.sg
Quan Wen*
Affiliation:
Georgetown University McDonough School of Business
*
quan.wen@georgetown.edu (corresponding author)
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Abstract

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This article 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.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , First View , pp. 1 - 35
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (https://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We thank two anonymous referees and Hendrik Bessembinder (the editor) for insightful and constructive feedback. We also thank Turan G. Bali, Laurent Barras (discussant), Ben Charoenwong (discussant), Zhanhui Chen, Celine (Yue) Fei (discussant), Francisco Gomes (discussant), Po-Hsuan Hsu, Marcin Kacperczyk (discussant), Julian F. Koelbel, Heebum Lee, Kai Li, Roger Loh, Pedro Matos, Abhiroop Mukherjee, Yosh Nozawa (discusssant), Lubos Pastor, Johan Sulaeman, Lucian Taylor, Tianyu Wang (discussant), Chelsea Yao, Bohui Zhang, Chu Zhang, Hong Zhang (discussant), Qifei Zhu, and seminar participants at the HKUST, University of Zurich, Tsinghua SEM, Korea University, Lancaster University, Shanghai Jiaotong University, University of Manchester, 2022 ESSEC Amundi Webinar on Climate Risk and the Bond Market, the 2023 AFA, the 2022 CICF, the 2022 EFMA, the 2022 World Finance Conference, the 2021 ABFER, the 2021 FMA, the 2021 SFS Cavalcade Conference, the 2021 Sustainable Finance Forum, the 2021 Annual GRASFI Conference, the 2020 Singapore Scholars Symposium, and CFA Society Singapore for helpful comments. All errors are our own.

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