European Corporate Bonds Reflect Heightened Climate Transition Risk Pricing

The transition to a low-carbon economy presents significant financial challenges as high-carbon emitting firms face increasing costs. Our research shows that transition risk is significantly priced in the European corporate bond market since the beginning of 2020, and that the size of this carbon premium has steadily increased since then. Over the full sample period, we find that a one standard deviation increase in log-carbon emissions increases the spread of the average corporate bond by 23 basis points. At the end of the sample period (2022), this effect grows to almost 49 basis points. Furthermore, we find that the size of the premium increases for bonds with a longer maturity, which indicates that investors appear to expect larger transition risks over longer time horizons. Overall, our research underscores the need for a consistent and forward-looking climate policy approach that stimulates an adequate pricing of transition risks. This helps an orderly climate transition that is beneficial for companies, investors, and financial institutions in the EU.