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Climate Regulatory Risks and Corporate Bonds

Abstract: Investor and policymaker concerns about climate risks suggest these risks should affect the risk assessment and pricing of corporate securities, particularly for firms facing stricter regulatory enforcement. Using corporate bonds, the authors find support for this hypothesis. Employing a shock to expected climate regulations, they show climate regulatory risks causally affect bond credit ratings and spreads. A structural credit model indicates that the increased spreads for high carbon issuers, especially those located in stricter regulatory environments, are driven by changes in firms' asset volatilities rather than asset values, highlighting that regulatory uncertainty affects security pricing. The results have important implications for policy-making.

Keywords: climate risks; regulatory risk; fixed income;

JEL Classification: G00; G24; G38;

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Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2022-04-01

Number: 1014

Note: Revised January 2024.