Corporate Bonds and Climate Change Risk

Abstract

Several industry participants have actively started managing the environmental externalities of their economic activities. As environmental policies become clear(er), the asset prices would likely evolve to drive transition to a low-carbon economy. With this article the authors intend to highlight to investors and portfolio managers the significance and financial materiality of climate change risk to the value of their developed-market corporate-bond portfolios. This article shows that, even though the broader credit market and bond spreads are yet to systematically incorporate the impact of climate policies or the potential for physical climate risk, these risks can have a material impact on the asset value of firms, and that the downside risk is large enough to adversely affect bondholders and other creditors of firms. The authors hope this article will encourage bond investors to take a more active role, along with equity holders and policymakers, in spurring firms onward in the transition to a low-carbon economy.