On Bond Returns in a Time of Climate Change

The study of the financial repercussions of low-carbon policy has focused mainly on stocks, leaving bonds out of the picture. The objective of this paper is to assess the impact of low-carbon policy upon European bond returns. This is done by extending the Fama and French two factor model for bonds...

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Bibliographic Details
Published in:The Energy journal (Cambridge, Mass.) Mass.), 2022-01, Vol.43 (1), p.139-160
Main Author: Ravina, Alessandro
Format: Article
Language:English
Subjects:
Bond portfolios
Bonds
Carbon
Climate change
Climatic changes
Economic aspects
Environmental aspects
Environmental factors
Environmental policy
Eurobond market
Statistical analysis
Stocks
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Summary:The study of the financial repercussions of low-carbon policy has focused mainly on stocks, leaving bonds out of the picture. The objective of this paper is to assess the impact of low-carbon policy upon European bond returns. This is done by extending the Fama and French two factor model for bonds with an EU-ETS participation factor: GMC (Green minus Carbon). This paper makes four contributions. Firstly, it provides a statistically highly significant measure of the sensitivity of bond portfolio returns to the GMC factor. Secondly, it shows the presence of a green premium in the European bond market in between 2008 and 2018. Thirdly, evidence is found that the addition of an environmental factor improves the performance of the original model. Fourthly, the carbon stress test put forward is able to indicate the effects of a plausible but more severe average EU-ETS carbon price on bond returns.
ISSN:0195-6574
1944-9089
DOI:10.5547/01956574.43.1.arav