Physical and transition risk premiums in euro area corporate bond markets

We study climate risk premiums in euro area corporate bond markets. As gauges of climate risk, we distinguish between physical and transition risks using textual analysis. Our findings show that, since the Paris agreement, physical risk is significantly priced in corporate bonds with longer-term maturities. Physical risk is also priced in bonds with shorter-term maturities, but the premium is smaller and less significant. The estimated physical risk premium reflects investors demanding higher future returns on bonds that underperform during adverse physical risk shocks. Our findings also point to a sizable transition risk premium, although the transition risk estimates are insignificant.

Keywords: Climate risk; physical risk; transition risk; corporate bonds
JEL codes G12; Q51; Q54

Working paper no. 761