The euro area carbon bond premium

We document a positive and significant carbon premium in euro area corporate bonds, reflecting investor demands for compensation due to climate transition risk. The premium is significant for Scope 1, 2, and 3 carbon emissions and is robust to alternative sample selection criteria and measurement methods of the emission variable. A one standard deviation increase in a firm's Scope 1 and 2 emissions raises its yield spread by 26 basis points. This premium, which systematically raises borrowing costs, arises from both preference and risk channels, with the component driven by preferences increasing rapidly from 2020 to early 2022. Firms receiving free EU ETS emission allowances face a 40% lower preference premium, highlighting the impact of carbon pricing on the cost of capital. The premium rises monotonically with bond maturity, signaling investor confidence in sustained carbon pricing.