The European Carbon Bond Premium
Published: 15 January 2024
We document a positive and statistically significant carbon premium that investors demand for investing in bonds issued by high carbon-emitting firms in the euro area. Over the entire sample period, we estimate that doubling a firm’s Scope 1 and 2 emissions results in an average increase of 6.6 basis points in the spread on the firm’s issued bonds. In addition, we find that the carbon premium has increased since 2020 and the effect reached 13.9 basis points by early 2022. These results suggest that European companies with high levels of carbon emissions are experiencing progressively higher financing costs. Our research also reveals a distinctive carbon premium term structure, rising with longer maturities. Interestingly, over time the term structure flat tens, suggesting investors’ confident anticipation of ongoing carbon pricing in the European Union at a stable pace.
Keywords: Carbon Premium; Carbon Premium Term Structure; Climate Change; Climate Transition Risk
JEL codes G12; G15; G23; Q51; Q54
Working paper no. 798
798 - The European Carbon Bond Premium
High Lights - The European Carbon Bond Premium
Research Highlights
- We document a positive and statistically significant carbon premium that investors demand when investing in bonds issued by high carbon-emitting firms in the euro area, based on Scope 1 and Scope 2 firm-level emissions. Pricing is stronger in the euro area compared to the US.
- Doubling a firm’s Scope 1 and 2 emissions results in an average 6.6 basis points increase in bond spreads, indicating progressively higher financing costs for European companies with elevated carbon emissions. The premium increased from early 2020, reaching an effect of 13.9 basis points by early 2022.
- The carbon premium exhibits a distinctive term structure, rising with longer maturities; however, over time, it flattens, reflecting investors’ confidence in a stable pace of carbon pricing in the European Union.
- We merge bond- and firm-level data from Bloomberg, Refinitiv Eikon and MSCI ESG Manager and conduct a panel regression at the bond level to estimate the effect of firm-level emissions on bond yield spreads.
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