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The term structure of carbon premia

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  • Dora Xia
  • Omar Zulaica

Abstract

This paper explores a carbon premium – the extra yield investors demand to buy bonds issued by firms with more greenhouse gas emissions – in the US corporate bond market. We analyse a carbon premium along two channels, via panel regression. One is the preference channel, under which the premium reflects investors' preference for firms that they perceive as being more environmentally responsible, all else equal. The other is the risk channel, where investors perceive more carbon-intensive firms as more prone to default. We test the preference channel by investigating the relationship between corporate bond yields and carbon emissions, while controlling for the probability of default (PD) and other bond characteristics. We examine the risk channel by analysing how carbon emissions affect the PD. We validate the existence of carbon premia in both channels, with the premium being larger for firms in more energy-intensive sectors. Moreover, the premium differs across maturities, giving rise to a humpshaped term structure of carbon premia, reaching its highest level at the belly of the curve (maturities of 15–20 years). For instance, a 50% reduction in carbon emissions by an energy-intensive firm can reduce credit spread of a bond in the belly issued by the firm by over 10 basis points.

Suggested Citation

  • Dora Xia & Omar Zulaica, 2022. "The term structure of carbon premia," BIS Working Papers 1045, Bank for International Settlements.
    • Handle: RePEc:bis:biswps:1045
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    References listed on IDEAS

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    Cited by:

    1. Fender, Ingo & McMorrow, Mike & Zulaica, Omar, 2022. "Sustainable management of central banks’ foreign exchange (FX) reserves," LSE Research Online Documents on Economics 115540, London School of Economics and Political Science, LSE Library.

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    More about this item

    Keywords

    climate change; carbon emissions; corporate bond spread; term structure.;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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