Corporate bonds’ exposure to climate risks is surrounded by substantial uncertainty. This climate beta uncertainty is both economically and statistically significantly priced in the cross-section of bond returns. Understanding this uncertainty is crucial, as it influences risk premia and the effectiveness of bonds as hedging instruments against climate risks. Since climate exposures exhibit distinct pricing patterns depending on return definitions, their impact on bond valuations varies. For total returns, bonds exposed to specific climate indices appear to offer potential hedges against future climate outcomes, but they trade at lower prices. For duration-adjusted returns, a higher climate beta is associated with higher future bond returns, indicating that greater exposure to climate risks commands a return premium once interest rate effects are controlled for. The results suggest that the hedging capacity of corporate bonds primarily stems from their linkage to duration-matched long-term government bonds, while credit returns—albeit small—compensate investors for bearing climate risk exposure.
