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

Author

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  • Duan, Tinghua
  • Li, Frank Weikai
  • Wen, Quan

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.

Suggested Citation

  • Duan, Tinghua & Li, Frank Weikai & Wen, Quan, 2025. "Is Carbon Risk Priced in the Cross Section of Corporate Bond Returns?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 60(1), pages 1-35, February.
    • Handle: RePEc:cup:jfinqa:v:60:y:2025:i:1:p:1-35_1
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    Citations

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    Cited by:

    1. DICKERSON, Alexander & NOZAWA, Yoshio & ROBOTTI, Cesare, 2025. "Factor Investing with Delays," Discussion Paper Series 771, Institute of Economic Research, Hitotsubashi University.
    2. Xu, Weidong & Zhu, Danyu & Gao, Xin & Xing, Lu & Li, Donghui, 2025. "The price of realized extreme climate events in the implied cost of equity capital: International evidence," Journal of Banking & Finance, Elsevier, vol. 180(C).
    3. Kim, Sehoon & Kumar, Nitish & Lee, Jongsub & Oh, Junho, 2025. "ESG lending," Journal of Financial Economics, Elsevier, vol. 173(C).
    4. Daniel Kim & Sébastien Pouget, 2026. "Do carbon emissions affect the cost of capital?," Post-Print hal-05470890, HAL.
    5. Nam, Hyun-Jung & Ryu, Doojin & Szilagyi, Peter G., 2025. "Technological progress and carbon emissions: Evidence from the European Union," Global Finance Journal, Elsevier, vol. 67(C).
    6. Luo, Qin & Ma, Feng, 2025. "Carbon transition risk and stock market premium," International Review of Financial Analysis, Elsevier, vol. 105(C).
    7. Mei, Dexiang & Luo, Qin & Zhang, Sisi, 2025. "Forecasting volatility in the Chinese stock market: Comparative performance of carbon transition risk indicators," Finance Research Letters, Elsevier, vol. 86(PB).
    8. Zhou, Peng & Li, Xiang & Shi, Xing & Jiang, Kun, 2025. "Spillover of the carbon risk along the supply chain: Evidence from the U.S. corporate bond market," Journal of Business Research, Elsevier, vol. 201(C).

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