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

Tinghua Duan, Frank Weikai Li and Quan Wen

Journal of Financial and Quantitative Analysis, 2025, vol. 60, issue 1, 1-35

Abstract: 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.

Date: 2025
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