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Pricing climate change risk in corporate bonds

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Abstract

Using a firm’s geographic footprint to measure its exposure to sea level rise (SLR), I find that corporate bonds bear a climate risk premium upon issuance. A one standard deviation increase in firms’ SLR exposure is associated with a 7 basis point premium, representing a 3% increase in average yield spread. This effect is more pronounced for geographically concentrated firms, within industries vulnerable to extreme weather conditions, and after the Paris Agreement. I do not find evidence that credit rating agencies account for SLR exposure at bond issuance. Results are robust to placebo tests and inverse propensity weighting to address possible endogeneity.

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Notes

  1. Responsible investment 2019, Norges Bank Investment Management.

  2. This is equivalent to 8–9 inches since 1880 and 12 inches by the end of century.

  3. According to S &P Global, outstanding US corporate debt instruments rated by S &P Global Ratings amount to $9.3 trillion as of Jan. 1, 2019, whereas the municipal market is approximately $3.8 trillion.

  4. The five-year municipal default rate since 2007 was 0.15%, whereas the five-year global corporate default rate was 6.92% since 2007.

  5. Data on HQs can also be obtained from Compustat. However, while it reports the address of a firm’s current HQ location, it back-fills this information for previous years, and does not control for HQ relocations.

  6. https://sraf.nd.edu/data/augmented-10-x-header-data/.

  7. Only 37 counties have SLR estimates, as listed in Table 1.

  8. Using the county distance database https://data.nber.org/data/county-distance-database.html

  9. Following Kling et al. (2021), I exclude business services which are too broad.

  10. Vulnerable Industries is an indicator variable that equals one for Agriculture (Fama–French Industry Code 1), Communication (Code 32), Energy - Mines (Code 28), Coal (Code 29), and Oil (Code 30) -, Food Products (Code 2), Health Care (Code 11), and Transportation (Code 40), and zero otherwise.

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Acknowledgements

I am thankful for the guidance and support of my dissertation adviser Linda Allen and committee members Brandon Lock, Sonali Hazarika, Lin Peng and Jun Wang. I am also thankful for the valuable comments and suggestions of David Ardia, Pedro Barroso, Monica Billio, James Bowden, Luis Ceballos (discussant), Chen Chen, Ricardo Cobral (discussant), Fabrizio Crespi, Xiaolu Hu, Michael King, Theophilus Teye Osah (discussant), Ali Sharhad (discussant), Kristif Struyfs, Stuart Turnbull, and Jue Wang (discussant), as well as the participants at the AFA Poster session, the 2021 European Financial Management Association (EFMA) conference, the 2021 International Workshop on Financial System Architecture and Stability (IWFSAS), the 2021 International Risk Management Conference (IRMC), the 2021 Financial Management Association conference (FMA), the 2021 World Finance and Banking Symposium, the 2020 Baruch Finance Brownbag and my fellow Ph.D. students at Baruch. I am also very grateful for receiving the John A. Doukas Doctoral Best Paper Award.

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    Elsa Allman

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Allman, E. Pricing climate change risk in corporate bonds. J Asset Manag 23, 596–618 (2022). https://doi.org/10.1057/s41260-022-00294-w

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